MICRO ECONOMICS – MCU 1205 Assignment No - 307

Q. Providing Examples Discuss the Practical Relavance of Demand And Supply Analysis. Concept of
Elasticity, Theory of Consumer Beaviour in Modern Day Business Decision Making.
Demand and Supply Analysis

Demand and Supply is the main mechanism which determine the market price and the behaviour in
the market. And the main two forces. Because demand is the source of income.

DEMAND
Demand – The ability and willingness to purchase a product under alternative prices in a given
period of time while other factors remain constant.

In a market economy the mechanism which determone the price is the demand and supply.
According to the law of demand, there is a negative relationship between price and quantity
demand. There are two reasons for that, they are,
1. The substitution effect
2. The income effect

ex : An example for substitution effect is,

Tea Coffee
Price Qd Price Qd
100 60 100 30
150 30 100 60

According to the above example the substitution effect is understood.

example 2- Hutch and Airtel are substitutes, Hutch introduced free call service among couple sims.
Then Airtel introduced free messages 500, MB and free call time among Airtel to Airtel for just 25/=.
Therefore the market stratergies and the price setting is very important for the survival. The
responsiveness of the consumer regarding the price changes of the substitute is positive.

The income effect is that, when the price change occur the consumers change in the quantity
demand as an effect on the real income is discussed here.
Therefore the market can determine the change in quantity demand when the prices are changed.
like that the consumers respond will vary according to the price changes and these things are backed
by the substitution effect and income effect.

Sometimes the demand behave beyond the law of demand, they are,
1. luxury goods
2. giffon goods
And also there are some other factors which determine the market demand and supply. For an
example,
 population –
* Due to the increase in the old population, the demand for medicine will be increased.
* when migrators or import of foreign labours for a prohect will increase the demand for a
product.

Reg No - 614376894 Page 1

MICRO ECONOMICS – MCU 1205 Assignment No - 307

Also there are certain events where the demand (not the quantity demanded) for products will
change.This will cause the demand curve to shift right. The events where the demand increase are,
1. Increase in the price substitutes.
2. Decrease in the price of complementory goods
3. Increase in the consumers demand
4. Increase in the consumers taste
5. Expect that the price of a certain good will increase in the future and vise versa.
example1 : The increase in the demand for taxi service in Colombo area will be due to,
 Increase in the prices of the bus fare
 Increase in the wages of the economy
 Hold an international cricket match in colombo
 Increase in the consumer’s interest for taxi service
example 2 : The decrease in the demand for the air conditioners.
 Increase in the electricity price
 Decrease in the price of fans
 Future expectations of decrease in the price
 Decrease in the consumer’s taste / interest.

Elasticity of demand
Now let’s focus on the elasticity of demand. Basically the elasticity of demand means the
responsiveness of quantity demand to a change in the factor in consideration. There are three types
of elasticities of demand. They are,
1. Price elasticity of demand
2. Cross elasticity of demand
3. Income elasticity of demand

1) Price elasticity of demand means the responsiveness of quantitiy demand to a change in

price. This is calculated as follows.
PED = percentage Change in quantitiy demand
percentage change in price
The classification of price elasticity of demand is follows.
I. Perfectly inelastic demand (ed =0 ) ex: medicine for high blood pressure
II. Inelastic demand (ed=<1) ex: Petrol , alcohol
III. Unitary elastic demand (ed = 1)
IV. Elastic demand (ed > 1) ex: mobile phones
V. Perfectly elastic demand (ed= ∞ ) ex: the price of a small scale entreprenure

Therefore the elasticity assists in,

1. When determining the policies on the decisions regarding the income/expenses of the
government. Such as tax imposement and providing subsidies. Generally the government
can earn more income by imposing taxes on the products like which are having alcohol,
ciggarates etc.
2. In order to identify the the effect on the income when doing a price change.
3. Assist in planning the import expenditure and export income of a country.

Reg No - 614376894 Page 2

MICRO ECONOMICS – MCU 1205 Assignment No - 307

2) Cross elasticity of demand means the responsiveness of quantitiy demand of one good
towards a change in price of another related good.
CED = ∆Qx % (change in the quantity demanded of the product in consideration)
∆Py% ( change in the price of the other product)

If the Cross elasticity of demand is,

cross
elasticity of
demand

positive(+) zero(0)
negative(-)
neither substitute
substitutes complement
nor complement

<1 >1 distant

close substitutes substitutes

The importance of the Cross elasticity of demand are,

1. To take the managerial decisions regarding the pricing stratergies.
2. To measure the inter relationship in demand between the goods
3. To make economic principles

3) Income elasticity of demand means the responsiveness of the quantity demand to a change
in the consumer’s income.
IED = ∆Q (change in qd)
∆Y (change in consumer income)
If the income elasticity of demand is,

income
elasticity of
demand

positive (+) negative (-)

normal inferior
good good

>1 <1
necessary luxury
goods goods
The business organization should determine whether their product is a necessary good or a
luxury good.

Reg No - 614376894 Page 3

MICRO ECONOMICS – MCU 1205 Assignment No - 307

The necessary goods are food, shelter, water etc. Rice is a necessary good for sri lankans. Therefore
they purchase rice for them everyday and it is a necessary good. Therefore the consumers spend
more on necessary good than luxury goods. And also this depends on the income level of the
consumer. Therefore the organization must understood whether to which consumer income level is
adressed and cater them accordingly.

Example : slippers are a wearing when everyone going out of the home. If we want we can
purchase BATA slippers. Most of the low incomed consumers go for that brand. But odel is
adreesed to the high income earners. They supply Arugambay shoes which costs nearly
850/=. Then that become a luxury good and BATA is just 200/=, and their consumer group is
different from ODEL.

SUPPLY
Supply – The willingness and ability to supply products at alternative prices in a given period of time
while other factors remain constant. The capacity to produce is a main factor that the supplier
should know. when increasing the production capacity the marginal cost factor arise, therefore the
profitability of the increase in capacity can be measured. Munchee will not icrease their production
if they can’t increase the cost to coverup the so called marginal cost.

And through the supply analysis the business organizations can make decisions regarding the
profitability of the current business and the shift of the resources to a more profitable business.

There are certain factors which determine the supply. They are,
1. Price of the product
2. Price of the resources
3. Technology
4. Number of suppliers
5. Government prinicples etc.
There is a positive relationship between supply and quantity supply which is supported by
 Increase in the opportunity cost
 Willingness to produce.
The change in the quantity supply will be due to the change in the price of the given product.
example :
Unit price QS Unit price QS
10 100 20 200
20 200 10 100

Elasticity of supply
the elasticity of supply means the responsiveness of the quantity supply to a change in the price of
the product in consideration.
the classification of price elasticity of supply is,
I. Perfectly inelastic supply (ed =0 ) ex: vegetable
II. Inelastic supply (ed=<1) ex: rice
III. Unitary elastic supply (ed = 1)
IV. Elastic supply (ed > 1) ex:
V. Perfectly elastic supply (ed= ∞ ) ex: diesel

Reg No - 614376894 Page 4

MICRO ECONOMICS – MCU 1205 Assignment No - 307

The elasticity of supply is determined by,

1. Resource movement between industries
2. Period in consideration
3. The ability to maintain stores and the durability
Example : since the supply of vegetables are lack during the rainy season,
The price of vegetables are high. Therefore the vegetables are having elastic demand during the
rainy season.

Consumer behaviour
After analysing the demand and supply and the elasticities, the consumer behaviour regarding this is
need to be discussed. That can be understood through,
1. Marginal utility analysis
2. Indifference curve analysis
3. budget line theory

1) Marginal utility analysis

Utitlity is the satisfaction gained by consuming a good or a service. The total utility is the total
satisfaction. The marginal utility is that the satisfaction gained by consuming one more unit.
The law of marginal utility is that when a person is consuming more and more of a given product
while other factors held constant, the marginal utility of that person tend to minimize eventually.
Example : assume a child is eating an ice cream. Accordingly if that child consume 10 ice creams at
once,the marginl utility can be assessed as follows.

No. of ice-creams Marginal utility

01 100
04 75
06 50
08 25
10 0
Accordingly the business firms can get an idea to their business stratergies regarding he consumer’s
behaviour. Now a days most of the organizations go for product diversification. Its because of the
marginal utility of the consumer.
Example 1: earlier in the tution classes there was a system of writing the whole lessons or the
lecture’s teachings by the students. Due to the time constraints, market attraction and also
considering the mrginal utility they tend to print the tutes or the study materials. Which increase the
attraction of the consumers too. Then the consumers tend to shift from bored writing classes to tute
classes.
example 2 : Unilever introduces more product differenciations. earlier they had RINSO washing
powder, later they renamed that brand as RIN with certain changes. accordingly the management
should be tactful to manage the consumer’s behaviour.

Reg No - 614376894 Page 5

MICRO ECONOMICS – MCU 1205 Assignment No - 307

2) Indifference preference analysis

Indifference preference analysis depicts the combinations of the two goods which are having
equal utility to the consumer depending on the neture rather than measuring the
satisfaction or utility.
Indifference curve
The consumer’s preference for a combination which gives equal satisfaction to the
consumer. For an example see the combination of the following.
Ex:
Rice Sarees
20 05
15 10
10 15
05 20
Budget line
budget line is an income constraint. this is because we can spend only how muh we earn.
assume that you are having an fixed income, so your ability to purchase will be limited to the
budget that you have. therefore according to the budget line the consumer’s behaviour vary
according to the to the given level of income.
as mentioned above before the organizations should know that to which income level that
do they serve. then the organization can survive.

Therefore through the demand and supply analysis, elasticity and the consumer behaviour
will assist in the business organization to become a successful one.

Reg No - 614376894 Page 6