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• Supply • Law of Supply • Elasticity of Supply • Equilibrium Price • Demand
Forecasting

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 Chapter 1 — Theory of Demand
1.1 Meaning of Demand

Demand refers to the quantity of a good or service that consumers are willing and able to buy at various
prices during a given period of time. Two key aspects of demand are willingness AND ability to pay — both
must be present for effective demand.

Demand = Desire + Ability to Pay + Willingness to Pay A desire without purchasing power is NOT
demand. For example, a poor man may desire a luxury car, but without money it is not economic demand.

1.2 Types of Goods

Type of Good Description Example

Consumer Goods Goods used for final consumption — satisfy Food, clothing, TV, phone
human wants directly.

Producer / Capital Goods used in the production of other goods Machinery, tools, factory equipment
Goods (durable).

Perishable Goods Goods consumed within a short time; cannot be Vegetables, fish, milk
stored long.

Durable Goods Goods that can be used repeatedly over a long Refrigerator, car, furniture
period of time.

Complementary Goods used together; demand is jointly Car and petrol, pen and ink
Goods determined.

Substitute Goods Goods that can replace each other; rise in one Tea and coffee, Pepsi and Coke
raises demand for other.

Inferior Goods Goods whose demand falls as consumer income Coarse grains, cheap transport
rises.

Normal / Superior Goods whose demand rises with increase in Branded clothing, restaurant meals
Goods consumer income.

Giffen Goods Inferior goods where demand RISES with price Irish potato famine example
increase (paradox).

Veblen / Prestige Goods consumed for status; demand rises with Luxury watches, designer clothes
Goods price (snob effect).

1.3 Determinants of Demand

Demand for a commodity depends on many factors. The most important is Price, but other factors also
significantly influence demand.

Price of the Good As price rises, demand falls (inverse relationship). The most important
determinant.

Income of Consumer As income rises, demand for normal goods rises; demand for inferior goods
falls.

Price of Related Goods If price of a substitute rises, demand for this good rises. If price of a
complement rises, demand for this good falls.

Tastes & Preferences Change in fashion, habit, or preference shifts demand up or down.

Population Size Larger population → greater total demand for goods and services.

Future Price If prices expected to rise, demand rises today. If expected to fall, demand falls
Expectations today.

Advertising & Effective advertising increases brand awareness and boosts demand.
Marketing

Government Policy Taxes, subsidies, and regulations can increase or decrease demand.

Seasonal Factors Demand for certain goods rises in specific seasons (e.g., raincoats in
monsoon).

Credit Availability Easy credit/EMI facility increases demand for durable goods (cars, appliances).

1.4 Law of Demand

Law of Demand: Other things being equal (ceteris paribus), the quantity demanded of a good increases
when its price falls and decreases when its price rises. In other words, there is an inverse relationship
between price and quantity demanded.
 Price (P)
Demand Curve (DD)

A As Price falls (P1→P2),

P1
Quantity demanded
rises (Q1→Q2).

Inverse relationship
between Price and
DD Quantity demanded.

B
P2

O Quantity (Q)
Q1 Q2

Fig 1.1 — Downward-sloping Demand Curve (DD)

Assumptions of the Law of Demand

• Income of the consumer remains constant
• Prices of related goods (substitutes and complements) remain constant
• Tastes, preferences, and habits of consumers remain unchanged
• No change in the size of population
• No change in expectations about future prices
• No change in government policy (taxes/subsidies)

Exceptions to the Law of Demand

The law of demand does NOT apply in certain special cases:

✘ Giffen Goods: Inferior goods where demand rises with price (Irish Potato Famine). Named after Sir
Robert Giffen.
✘ Veblen / Prestige Goods: Luxury goods bought for status — higher price increases demand
(Snob/Veblen Effect).
✘ Speculation (Expected Price Change): If consumers expect price to rise further, they buy more even at
higher prices.
✘ Necessities: Essential goods like medicines — demand does not fall even if price rises significantly.
✘ Ignorance Effect: Some consumers associate higher price with better quality and buy more.

1.5 Movement vs. Shift in Demand Curve

 Movement Along Demand Curve Shift of Demand Curve
• Caused by change in own price only • Caused by change in any factor other than
• Demand curve stays the same own price

• Move UP the curve → price rises → Qd falls • Entire curve shifts to a new position
(contraction) • Shift RIGHT → increase in demand (income up,
• Move DOWN the curve → price falls → Qd rises tastes, etc.)
(extension) • Shift LEFT → decrease in demand

1.6 Elasticity of Demand

Elasticity of Demand measures the degree of responsiveness of the quantity demanded of a good to a
change in its price (or income, or price of related goods). It quantifies how sensitive consumers are to price
changes.

Price Elasticity of Demand (PED) Formula: Ed = (% Change in Quantity Demanded) ÷ (% Change in

Price) = (ΔQ/Q × 100) ÷ (ΔP/P × 100) = (ΔQ/Q) ÷ (ΔP/P)

Five Types of Price Elasticity of Demand

Perfectly Unitary Perfectly

Inelastic Elastic
Inelastic Elastic Elastic
(Ed<1) (Ed>1)
(Ed=0) (Ed=1) (Ed=∞)

Fig 1.2 — Five Types of Price Elasticity of Demand

Type Value of Description Curve Shape

Ed

Perfectly Ed = 0 Quantity demanded does not change at all, regardless Vertical line (parallel to
Inelastic of price change. E.g., life-saving drugs. Y-axis)

Inelastic (Less Ed < 1 Quantity demanded changes less proportionately than Steep curve
Elastic) price change. E.g., necessities, salt.

Unitary Elastic Ed = 1 Quantity demanded changes in exact proportion to price Rectangular hyperbola;
change. passes through origin

Elastic (More Ed > 1 Quantity demanded changes more proportionately than Flatter curve
Elastic) price change. E.g., luxury goods.

Perfectly Elastic Ed = ∞ Infinite quantity demanded at one price. Any price rise Horizontal line (parallel
→ zero demand. E.g., perfectly competitive market. to X-axis)

Other Types of Elasticity of Demand

Income Elasticity of Measures change in quantity demanded due to change in consumer income.
Demand Ey = % Change in Qd ÷ % Change in Income. Positive for normal goods,
negative for inferior goods.
Cross Elasticity of Measures change in demand for good X due to change in price of good Y. Ec =
Demand % Change in Qd of X ÷ % Change in Price of Y. Positive for substitutes
(tea/coffee), Negative for complements (car/petrol).

Advertising Elasticity Measures responsiveness of demand to change in advertising expenditure. Ea

= % Change in Qd ÷ % Change in Advertising spend.

Factors Affecting Elasticity of Demand

• Nature of the commodity: Necessities (inelastic) vs. Luxuries (elastic)
• Availability of substitutes: More substitutes → more elastic
• Proportion of income spent: Higher proportion → more elastic (e.g., car vs. salt)
• Time period: Demand is more elastic in the long run (consumers adjust)
• Number of uses: More uses → more elastic (electricity)
• Habit and addiction: Habitual goods (cigarettes, alcohol) are inelastic
• Complementarity: Complements tend to have inelastic demand
• Durability: Durable goods (can postpone purchase) → more elastic
 Chapter 2 — Theory of Supply
2.1 Meaning of Supply

Supply refers to the amount of a good or service that producers are willing and able to offer to the
market at various prices during a given period of time. Two key aspects: (1) Supply refers to what is
offered for sale — not what is finally sold. (2) Supply is a flow — it is a certain quantity per
day/week/month.

Supply ≠ Stock. Stock is the total amount available. Supply is only what is actually offered for sale at a
given price. A seller may have large stock but offer only a part as supply depending on the prevailing price.

2.2 Determinants of Supply

While price is the most important determinant, many other factors affect supply:

Price of the The most important determinant. Higher price → higher profit → higher supply
Good/Service (direct relationship).

Price of Related Goods If price of wheat rises, firms shift to producing wheat, reducing supply of
corn/soya bean. Change in price of one good causes changes in relative
profitability across production lines.

Price of Factors of Rise in cost of land, labour, or capital → higher cost of production → reduced
Production supply. Example: rise in cost of land has a large effect on wheat production
cost.

State of Technology Technological innovations allow production of better quality/quantity with same
resources → increases supply. Outdated technology reduces supply.

Government Policy Commodity taxes (excise duty, import duties, GST) raise cost → reduce supply.
Subsidies lower cost → increase supply.

Goals of the Firm A firm aiming for market share may supply more even at lower profits. A
profit-maximising firm responds more sharply to price changes.

Natural Factors Floods, droughts, and favourable weather directly impact agricultural supply.

Infrastructure & Market Better roads, storage, and distribution networks increase supply. Market
Structure structure (monopoly vs. competition) also affects willingness to supply.

2.3 Law of Supply

 Law of Supply: Other things being equal (ceteris paribus), the quantity of a good produced and offered for
sale increases with an increase in its price and decreases as the price falls. There is a direct
relationship between supply and price.

Price (P)
Supply Curve (SS)

SS
As Price rises (P1→P2),
B
P2 Quantity supplied
also rises (Q1→Q2).

Direct relationship
between Price and
Quantity supplied.

A
P1

O Quantity (Q)
Q1 Q2

Fig 2.1 — Upward-sloping Supply Curve (SS)

Rationale for Law of Supply

At higher prices, a supplier looks at greater profit margins — this acts as an incentive for increasing the
supply. The law holds for most day-to-day situations.

Exceptions to the Law of Supply

✘ Labour supply at high wages: Beyond a point, workers prefer leisure over income — labour supply may
fall with rising wages (backward-bending supply curve).
✘ Agricultural goods: Supply depends on season and nature — price change may not affect supply in
short run.
✘ Perishable goods: Sellers must sell regardless of price to avoid spoilage.
✘ Art, antiques, and rare items: Supply is fixed and cannot increase even with price rise.
✘ Emergency/distress sale: Sellers may sell more at lower prices to raise cash urgently.

2.4 Movement vs. Shift in Supply Curve

Movement Along Supply Curve Shift of Supply Curve

• Caused only by change in own price • Caused by change in any factor other than
• Supply curve stays the same own price
• Move UP the curve → price rises → Qs rises • Entire supply curve shifts
(extension) • Shift RIGHT → increase in supply (better tech,
• Move DOWN the curve → price falls → Qs falls subsidy)
(contraction) • Shift LEFT → decrease in supply (higher input
costs, tax)
2.5 Elasticity of Supply

Elasticity of Supply establishes a quantitative relationship between the supply of a commodity and its
price. It measures how much the quantity supplied responds to a change in price.

Price Elasticity of Supply (PES) Formula: Es = (% Change in Quantity Supplied) ÷ (% Change in Price) =
(ΔQ/Q) ÷ (ΔP/P) Point Elasticity: Es = (dQ/dP) × (P/Q) Arc Elasticity: Es = [(Q1–Q2)/(Q1+Q2)] ×
[(P1+P2)/(P1–P2)]

Five Types of Price Elasticity of Supply

Perfectly Unitary Perfectly

Less Elastic More Elastic
Inelastic Elastic Elastic
(Es<1) (Es>1)
(Es=0) (Es=1) (Es=∞)

Fig 2.2 — Five Types of Price Elasticity of Supply

Type Value of Description Supply Curve

Es

Perfectly Es = 0 Quantity supplied stays constant whatever the price. Vertical line (parallel to
Inelastic E.g., Mona Lisa painting — cannot be increased at Y-axis)
any price.

Relatively Less Es < 1 Supply changes less than proportionately with price. Steep upward slope
Elastic Common for goods needing long production time.

Unitary Elastic Es = 1 Quantity supplied changes in exact proportion to Straight line through origin
price change.

Relatively More Es > 1 Supply changes more than proportionately with Flatter upward slope
Elastic price. Common for goods easily produced.

Perfectly Elastic Es = ∞ Supply becomes zero with a slight fall in price and Horizontal line (parallel to
infinite with a slight rise. Suppliers supply any X-axis)
quantity at a fixed price.
 Chapter 3 — Equilibrium Price
3.1 Meaning of Equilibrium

Equilibrium means a state of no change. At the equilibrium price, the market is in balance — the quantity
demanded by buyers equals the quantity supplied by sellers. Both market forces of demand and
supply operate in harmony at the equilibrium price.

The equilibrium price is also called the Market Clearing Price. Graphically, it is represented by the
intersection of the demand (DD) and supply (SS) curves. The determination of market price is the
central theme of microeconomics — which is why microeconomic theory is also called Price Theory.

Price

SS

E (Equilibrium)
Pe

DD
O Quantity
Qe
Fig 3.1 — Equilibrium at Intersection of DD and SS Curves

3.2 Determination of Equilibrium Price

At equilibrium price Pe, quantity demanded = quantity supplied = Qe. • If price > Pe → Surplus (excess
supply): sellers lower prices until equilibrium is restored. • If price < Pe → Shortage (excess demand):
buyers bid prices up until equilibrium is restored.

Situation What Happens How Equilibrium Restores

Surplus (Price too Quantity supplied > Quantity Sellers reduce price → Qd rises, Qs falls →
high) demanded. Unsold stock accumulates. equilibrium restored.

Shortage (Price too Quantity demanded > Quantity Buyers bid price up → Qd falls, Qs rises →
low) supplied. Consumers cannot find the equilibrium restored.
goods.

At Equilibrium (Pe) Quantity demanded = Quantity Market clears. Both buyers and sellers are
supplied. No tendency to change. satisfied.
3.3 Changes in Equilibrium

Effect of Demand Change Effect of Supply Change

• Demand increases (curve shifts right) → higher • Supply increases (curve shifts right) → lower Pe
Pe and higher Qe but higher Qe
• Demand decreases (curve shifts left) → lower • Supply decreases (curve shifts left) → higher Pe
Pe and lower Qe but lower Qe
• Caused by: income change, preference shift, • Caused by: technology change, input costs, govt.
price of substitutes/complements policy (tax/subsidy)
 Chapter 4 — Demand Forecasting
4.1 Meaning and Definition

Demand Forecasting is the process of finding values for demand in future time periods. It is an estimate
of sales during a specified future period based on proposed marketing plan and a set of particular
uncontrollable and competitive forces.

In the words of Evan and Strick, demand forecasting is "an estimate of sales during a specified future
period based on proposed marketing plan and a set of particular uncontrollable and competitive
forces."

4.2 Significance / Importance of Demand Forecasting

Formulation of Demand forecasting helps in meeting the demand by ensuring uninterrupted

Production Policy production and supply of goods and services.

Formulation of Price It helps in formulating an effective price mechanism to deal with market
Policy fluctuations and conditions like inflation.

Sales Forecasting Demand forecasting aids at meeting demand for the long-term and contributes
to long-term financial planning, aligning acquisition of funds, suitable terms and
conditions.

Decisions Regarding Demand forecast determines the production level, which provides a base for
Production Capacity decisions related to the expansion of the production unit or size of the plant.

Labour Requirements Demand forecasting initiates the expansion of business, thus leading to the
estimation of required human resource to accomplish business goals and
objectives.

Capital Investment It helps in providing evidence for the long-term existence of an organisation,
Decisions following objectives such as justifying the statement.

Long-term Financial Demand forecasting for the long term contributes to long-term financial
Planning planning, aligning acquisition of funds at reasonable rates and suitable terms.

4.3 Types of Demand Forecasting

Basis Type Description

By Time Period Short-term Forecasting Forecasting for immediate future (up to 1 year). Used for
production scheduling, inventory management.

By Time Period Long-term Forecasting Forecasting beyond 1 year. Used for capacity planning, capital
investment, workforce planning.
By Level Micro-level Forecasting Forecasting for a specific product, firm, or industry.

By Level Macro-level Forecasting Forecasting for entire industry or economy (national/global level).

By Scope Active Forecasting Forecasting assuming the firm will change its marketing mix
(prices, promotion, distribution).

By Scope Passive Forecasting Forecasting assuming no change in the firm's current policies.

4.4 Methods / Techniques of Demand Forecasting

A) Survey Methods (Primary Data)

Method Description Suitability

Consumer Survey / Consumers are directly asked about their expected New product launches;
Direct Interview purchases. Can be complete enumeration (all consumers) capital goods
or sample survey.

Expert Opinion Method Opinions of sales force, dealers, or industry experts are Established markets; quick
(Delphi) collected and consolidated. Experts estimate estimates
independently, then views are reconciled.

Market Experiments Actual experiments conducted in controlled market areas New products; testing
(test marketing). Demand is observed under different marketing strategies
price/promotional conditions.

B) Statistical / Mathematical Methods (Secondary Data)

Method Formula/Approach Description

Trend Projection / Time Projects past data Uses historical sales data to identify patterns: trend, seasonal,
Series Analysis into future using cyclical, and random fluctuations. Most reliable for established
trend line products.

Regression Analysis Q = a + bP + cY + dA Establishes a quantitative relationship between demand

+ ... (dependent variable) and its determinants (independent
variables). Most widely used statistical method.

Barometric Method Uses leading Uses economic indicators (GDP, investment, industrial output)
indicators that tend to lead or lag the demand for a product.

Econometric Model System of A system of interrelated equations representing the economy or

simultaneous industry. Most sophisticated method; used for macro
equations forecasting.

Input-Output Analysis Industry Studies inter-industry relationships to forecast demand for

interdependence intermediate goods. Useful when the product is used as raw
matrix material by other industries.

4.5 Steps in Demand Forecasting Process

Step 1 Setting the Objective Define what is to be forecasted — for which product, market, and time period.
 Determining the Time
Step 2 Decide whether short-term or long-term forecasting is needed.
Perspective

Gather primary data (surveys, experiments) or secondary data (historical sales,

Step 3 Data Collection
industry reports).

Selecting Forecasting Choose the appropriate method based on data availability, product type, and
Step 4
Method time horizon.

Step 5 Analysing Data Apply statistical/mathematical tools to identify patterns and relationships.

Step 6 Making the Forecast Use the chosen model to project future demand values.

Compare forecasted vs. actual demand and refine the model for the next
Step 7 Monitoring Accuracy
period.
 QUICK REVISION — All Key Points at a Glance
Important Definitions

Demand Quantity of a good consumers are willing AND able to buy at various prices in a
given period.

Law of Demand Inverse relationship between price and quantity demanded (ceteris paribus).

Price Elasticity of (% ΔQd) ÷ (% ΔP). Measures responsiveness of Qd to price change.

Demand (Ed)

Income Elasticity (% ΔQd) ÷ (% ΔIncome). Positive for normal goods; negative for inferior goods.

Cross Elasticity (% ΔQd of X) ÷ (% ΔP of Y). Positive for substitutes; negative for complements.

Giffen Good Inferior good where demand RISES with price (exception to law of demand).

Veblen Good Prestige/luxury good where demand rises with price (snob effect).

Supply Quantity of a good producers are willing and able to offer at various prices in a
given period.

Law of Supply Direct relationship between price and quantity supplied (ceteris paribus).

Price Elasticity of (% ΔQs) ÷ (% ΔP). Measures responsiveness of Qs to price change.

Supply (Es)

Equilibrium Price Price at which Qd = Qs. Market clearing price. No tendency to change.

Surplus When market price > equilibrium price → Qs > Qd → price falls to equilibrium.

Shortage When market price < equilibrium price → Qd > Qs → price rises to equilibrium.

Demand Forecasting Process of estimating future demand for a product based on historical data and
market conditions.

Chapter-wise Summary

Chapter Core Topic Key Points Formulas

Ch 1 Demand Law of Demand & • Inverse P-Q relationship • 5 types of price Ed = %ΔQd / %ΔP Ey =
Elasticity elasticity • Income & cross elasticity • Exceptions: %ΔQd / %ΔY Ec =
Giffen, Veblen • Movement vs. shift of DD curve %ΔQd(X) / %ΔP(Y)

Ch 2 Supply Law of Supply & • Direct P-Q relationship • 5 types of price Es = %ΔQs / %ΔP Point:
Elasticity elasticity of supply • Exceptions: labour, (dQ/dP)×(P/Q) Arc: [(Q1-
perishables, art • Movement vs. shift of SS curve Q2)/(Q1+Q2)]×[(P1+P2)/
• Point and Arc elasticity (P1-P2)]
Ch 3 Market Price • DD intersects SS at equilibrium • Surplus → At E: Qd = Qs Pe =
Equilibrium Determination price falls • Shortage → price rises • Also called equilibrium price Qe =
market clearing price • Micro = Price Theory equilibrium quantity

Ch 4 Demand Forecasting • Survey methods: consumer survey, expert Regression: Q = a + bP

Forecasting opinion, market experiment • Statistical: trend + cY + dA Survey +
analysis, regression, barometric, econometric, Statistical
I-O analysis • 7 steps in forecasting process