Demand, Supply, and Cost Concepts in Economics

Posted on Feb 24, 2025 in Economy

Demand and Its Determinants

1. Shortage in the future = increased consumption.

2. Veblen effect: Status symbols (e.g., diamonds) = high price = high consumption & vice versa.

3. Ignorance = more consumed even if prices are high.

4. Perceptions about quality = better quality = higher price.

5. Necessary items: Irrespective of price rise = consumption remains the same (e.g., life-saving medicines).

6. Inferior goods: (Public perceptions of goods – assume it is inferior) – when prices of such goods fall, demand is low. Called Giffen paradox. Demand curve slopes upwards.

Factors Determining Demand

  1. Income of consumer: Directly linked to income – higher income, greater the demand.
  2. Price: Inverse relationship, higher the price, lower the demand.
  3. Tastes & Preferences: Subjective factor, habitual.
  4. Prices of related goods:
    • Substitute goods (e.g., Tea & coffee): If the price of tea rises, and the price of coffee remains the same, demand for coffee rises.
    • Complementary goods (e.g., Car & petrol): If the price of petrol rises, and the price of cars remains the same, the demand for cars will decrease and vice versa.
  5. Future expectations: An expectation of a price rise in the future, demand for the good will be high now. If expectations are a decrease in price in the future, demand will be postponed now.
  6. Effect of advertisement campaigns.

Market Demand

  1. Change in weather: e.g., demand for woollens changes depending on the season – affects market demand.
  2. Changes in fashion: Demand changes because of fashion.
  3. Changes in money circulation: Supply of money increases in the country, results in greater demand.
  4. Changes in the size of the population: Increase/decrease causes changes in demand for goods.
  5. Technological changes: Inventions replace outdated products (e.g., radios replaced by TVs).
  6. Discovery of cheap substitutes: Availability of new substitutes affects the demand of those goods it replaces (e.g., demands of I-pads have increased affecting demand for big computers).
  7. Advertisement effects: Continuous and persistent campaigns influence demand.
Extension/ContractionIncrease/Decrease
Price changes, other factors fixedPrice fixed, other factors change
Same demand curveShift in demand curve

Classification of Demand

  1. Direct and derived demand: Demand for final goods & services – goods that can be readily used – is direct demand (e.g., Chocolate). Derived demand OR Induced demand – demand for factors of production (land, labour, capital & organisation) or anything used to produce goods. Depends on demand for final goods and services. However, the distinction between the two is of degree since raw material for one could be a final product for another (e.g., Milk used in chocolate is a final product for the milk seller, but a raw material for the chocolate manufacturer).
  2. Company demand: Demand for a commodity produced by an individual firm (e.g., Demand for phones produced by Tatar). Industry demand OR Market share of the company: demand faced by all units producing phones. Thus, the firm’s demand is a percentage of industry demand.
  3. Demand for durable and non-durable goods:
    • Durable goods: Can be reused (e.g., Furniture). Durable producer goods (e.g., Machines). When a good is demanded as an addition to stock, it is NEW DEMAND.
    • Non-durable goods: Single-use goods – are perishable in nature (e.g., eggs, milk, vegetables) – used to meet current demand.
  4. Short-run demand: Influenced by price & income change & refers to existing demand. Long-run demand – size & pattern of demand existing in the long run – affected by growth in population, technological changes.
  5. Total market demand & market segment demand: Total market demand from all sectors. When this market is subdivided, it is market segment demand (e.g., Market divided into domestic & international markets). Market demand also divided on the basis of income, age, literacy = market segmentation.
  6. Joint demand & Composite demand: Two or more goods demanded at the same time to satisfy a particular want (e.g., Car & petrol = Joint demand). Composite demand refers to goods which can be used for more than one purpose (e.g., Electricity used for heating, cooling).
  7. Individual demand: Demand from an individual consumer. Market demand refers to the summation of demand of all the consumers.
  8. Joint demand & Composite demand: Two or more goods demanded at the same time to satisfy a particular want (e.g., Car & petrol = Joint demand). Composite demand refers to goods which can be used for more than one purpose (e.g., Electricity used for heating, cooling).

Supply and Its Determinants

Supply = quantity that a seller is willing and able to sell at different prices during a given period of time. Actual quantity that is offered for sale. Stock = total quantity that can be supplied. Stock is the basis of supply. Supply schedule is various quantities offered for sale at a particular price. As price increases, supply increases. Direct relationship.

Exceptions to the Law of Supply

  1. Labour supply: As wage rate increases, the supply of labour also increases, however, this happens only up to a point, after which even if wage increases, labour supply does not increase and the supply curve of labour actually starts sloping backwards. This is due to the fact that workers may prefer more leisure to work. This happens when the workers are assured to receive a fixed amount of wages.
  2. Savings: Normally when interest rates increase, savings also increase, however, savings may fall when the interest rate increases. This happens with some people who are only interested in a fixed income in the form of interest.
  3. Expectation of a change in price in the immediate future: If sellers expect a price rise in the future, they will curtail supply in the present to enable them to earn a profit in the future.
  4. Immediate need for cash: If a seller needs cash in the present he will supply a larger amount of the commodity at a lower price.
  5. Rare collections: In this case, supply cannot increase, even if the price rises.
  6. Closure of business: If the firm is closing down, it will offer the goods at a lower price to dispose of its stock.

Factors Affecting Supply

  1. Natural conditions: Supply increases if monsoons are good.
  2. Technological advancement: It leads to an increase in supply.
  3. Infrastructure improvement: Reduction in the cost of production, leading to an increase in supply.
  4. Availability of factors of production: If these are available at a cheaper rate, supply will increase and vice versa.
  5. Market structure: With monopoly, supply may increase or decrease.
  6. Government policy: Fiscal policy measures through taxation cause a change in supply – tax concessions lead to an increase in supply.
  7. Supply and Time element:
    • Supply in the market period: Very short period, stock is fixed for a few days for perishable commodities and a few months for durable commodities.
    • Short run period: Machinery and plants are constant, output can be altered by changing raw materials, labour.
    • Long run: All factors are variable, supply can be changed to cater to demand.

Demand Forecasting

Forecast = estimation – future situation. Minimise risk & uncertainty.

Types of Demand Forecasting

  1. Passive: Demand of previous years extrapolated & future predicted.
  2. Active: Impact of new policies.
  3. Firm
  4. Industry
  5. National
  6. Short term
  7. Long term
  8. Medium term
  9. Ex ante: Forecasting done for future periods
  10. Ex post: Forecast for both past and present to find out the credibility of the forecasting model.

Cost Concepts

Cost = expenditure on factors of production = remuneration.

Cost Concepts Explained

  1. Real cost: Actual cost of quantities of factors used in production & the toil involved in the process. An abstract cost.
  2. Money cost: Cost of actual production in money terms.
  3. Explicit OR Accounting cost: Cost incurred on factors of production & are recorded.
  4. Implicit OR Imputed cost: Cost incurred by firms on factors of production BUT NOT paid by the firm – usage of OWN resources – normal profit – entrepreneur – wages paid to himself. In ACCOUNTING – only explicit costs are considered. ECONOMIC VIEW – implicit cost should also be taken into account.
  5. Marginal cost: Cost incurred in producing an extra unit of a commodity. MC= TCn -TCn-1
  6. Incremental cost: Change in total cost due to changes in policy decisions implemented by the management.
  7. Opportunity OR Social cost: Next best alternative cost – sacrifice = opportunity cost. Purpose decided, other opportunities are sacrificed.
  8. Total cost (TC): Total expenditure incurred by the firm for producing a level of output. TC= TFC + TVC.
  9. Total fixed cost (TFC): TC incurred on fixed factors of production. Remains the same at ALL levels of output in the SHORT RUN. TFC= TC- TVC.
  10. Total variable cost (TVC): In SHORT RUN SOME factors are variable; varies with output levels. TVC= TC – TFC.