Demand Analysis

Demand Analysis

Demand is the quantity of a good or service that consumers are willing and able to buy at various prices during a given period, ceteris paribus. Understanding demand is fundamental for business — it determines revenue, guides pricing strategy, and shapes marketing decisions.

Law of Demand

The law of demand states that, ceteris paribus, as the price of a good increases, the quantity demanded decreases, and vice versa. This inverse relationship creates a downward-sloping demand curve. Reasons: substitution effect (higher price makes alternatives more attractive), income effect (higher price reduces purchasing power), and diminishing marginal utility (additional units give less satisfaction, so consumers only buy more at lower prices). Exceptions: Giffen goods (inferior goods where income effect dominates) and Veblen goods (luxury goods where high price signals status).

Individual and Market Demand

Individual demand is one consumer's demand at various prices. Market demand is the horizontal summation of all individual demands — at each price, add up all individuals' quantities demanded. Market demand determines total sales potential and is what firms primarily focus on.

Determinants of Demand

Factors that shift the demand curve: Income — normal goods (demand increases) vs inferior goods (demand decreases). Prices of related goods — substitutes (Coke/Pepsi) and complements (cars/petrol). Consumer tastes — advertising, trends, health awareness. Population/demographics. Expectations — expected price increases boost current demand. Government policy — subsidies increase, taxes decrease demand.

Movement vs Shift

A movement along the demand curve occurs when price changes. A shift of the demand curve occurs when a non-price determinant changes. Confusing the two is the most common error in economics.

Price Elasticity of Demand

PED = %ΔQd / %ΔP. |PED| > 1: elastic (luxuries, many substitutes). |PED| < 1: inelastic (necessities, few substitutes). |PED| = 1: unit elastic. Revenue rule: elastic demand → price decrease increases revenue. Inelastic demand → price increase increases revenue. The most practically useful concept for pricing strategy.

Other Elasticities

Income elasticity (YED) = %ΔQd/%ΔY. Positive for normal goods, negative for inferior goods. YED > 1 = luxury, 0 < YED < 1 = necessity. Cross-price elasticity (XED) = %ΔQd of A / %ΔP of B. Positive = substitutes, negative = complements, zero = unrelated.

Consumer Surplus

Difference between willingness to pay and actual price. Area between demand curve and market price. Increases when prices fall. Businesses capture it through price discrimination.

Summary

Demand analysis — law of demand, determinants, elasticity, and consumer surplus — provides essential tools for pricing, marketing, and forecasting decisions.

Worked Example: Price Elasticity of Demand

When the price of a smartphone drops from Rs 30,000 to Rs 25,000, the quantity demanded increases from 500 to 700 units per month. Calculate PED and determine if the firm should have reduced the price.

Solution (using midpoint/arc elasticity method):

%ΔQ = [(700−500)/((700+500)/2)] × 100 = [200/600] × 100 = 33.33%

%ΔP = [(25000−30000)/((25000+30000)/2)] × 100 = [−5000/27500] × 100 = −18.18%

PED = 33.33% / −18.18% = −1.83 (|PED| = 1.83)

Interpretation: Since |PED| > 1, demand is elastic. A 1% price decrease leads to 1.83% increase in quantity demanded.

Revenue check:

Conclusion: The price reduction was a good decision — total revenue increased by Rs 25 lakhs because demand is elastic. The quantity increase (40%) more than compensated for the price decrease (16.7%).

Worked Example: Income Elasticity

A Nepali household’s monthly income rises from Rs 40,000 to Rs 50,000. Their spending on restaurant meals increases from Rs 3,000 to Rs 5,000, while spending on instant noodles decreases from Rs 1,200 to Rs 800.

Restaurant meals: YED = [(5000−3000)/3000] / [(50000−40000)/40000] = (66.67%) / (25%) = +2.67 — luxury good (YED > 1). Income growth will strongly boost restaurant demand.

Instant noodles: YED = [(800−1200)/1200] / [(50000−40000)/40000] = (−33.33%) / (25%) = −1.33 — inferior good (YED < 0). As incomes rise, demand falls — consumers switch to better alternatives. This explains why instant noodle companies should target lower-income segments.

Nepal Business Applications

Nepal Oil Corporation: Petrol demand is highly inelastic (PED ≈ −0.2) because few substitutes exist for transport fuel. Price increases significantly boost NOC revenue. Telecom: Mobile data demand is elastic — Ncell and NTC compete on data package prices because small price reductions attract many users. Tourism: Nepal’s tourism demand has high income elasticity for international tourists (luxury good) — global recessions significantly reduce tourist arrivals.

Exam Tips

Tip 1: Always state the formula, show substitution, and interpret the result — three marks for three steps. Tip 2: Use midpoint method for arc elasticity unless specifically told to use point elasticity. Tip 3: Remember: elastic demand → price cut increases revenue; inelastic → price increase raises revenue. Tip 4: Clearly distinguish movement along (price change) from shift of curve (non-price factor). Tip 5: Income elasticity sign tells you normal (+) vs inferior (−); magnitude tells you necessity (0-1) vs luxury (>1).