Demand Analysis: Law, Factors, Elasticity & Applications

Core Concepts: Law of Demand and Demand Function

1. Law of Demand: The Inverse Relationship

The law of demand states that, ceteris paribus (all else equal), when the price of a good rises, the quantity demanded falls, and vice versa. This inverse relationship arises because:

• Substitution effect: Higher prices make substitutes more attractive (e.g., switching from tea to coffee if tea prices rise).
• Income effect: Higher prices reduce purchasing power (e.g., fewer mobile data bundles bought if Ncell raises tariffs).

Why the Demand Curve Slopes Downward

Worked Example: Daraz Discounts Daraz frequently offers 20% discounts on electronics. Using the demand function for smartphones: $$Q_d=1000-2P$$

• Original price (P₀) = NPR 20,000 → $Q_{d0}=1000-2(20)=960$ units.
• Discounted price (P₁) = NPR 16,000 → $Q_{d1}=1000-2(16)=968$ units. Result: A NPR 4,000 price drop increases demand by 8 units (elasticity effect; see Section 3).

2. Determinants of Demand (Non-Price Factors)

These shift the entire demand curve (not movement along the curve). Use the mnemonic "TRIBE" to remember:

Visual: Shift vs. Movement

3. Price Elasticity of Demand (PED): Measuring Sensitivity

PED quantifies how much quantity demanded responds to a price change: $$\text{PED}=\frac{\%\text{ Change in Quantity Demanded}}{\%\text{ Change in Price}}=\frac{\Delta Q_d/Q_d}{\Delta P/P}$$

Types of Elasticity

Worked Example: Ncell Tariff Hike Ncell increases data price from NPR 100/GB to NPR 120/GB (20% rise).

• Initial demand (Q₀) = 500 GB, New demand (Q₁) = 450 GB (10% drop). $$\text{PED}=\frac{-10\%}{+20\%}=0.5(\text{Inelastic})$$ Implication: Ncell’s revenue increases because demand doesn’t drop proportionally.

Factors Affecting PED

mindmap
  root((Factors Affecting PED))
    Availability of Substitutes
      Many substitutes → Elastic
      Few substitutes → Inelastic
    Necessity vs. Luxury
      Necessities (e.g., rice) → Inelastic
      Luxuries (e.g., iPhones) → Elastic
    Proportion of Income
      High-cost items (e.g., houses) → Elastic
      Low-cost items (e.g., matches) → Inelastic
    Time Period
      Short-run → Inelastic (no time to adjust)
      Long-run → Elastic (consumers find alternatives)

4. Income Elasticity of Demand (YED)

Measures how demand changes with income: $$\text{YED}=\frac{\%\text{ Change in Quantity Demanded}}{\%\text{ Change in Income}}$$

Real-World Tie-In: Khalti vs. Cash

• Low-income groups (YED < 0): Prefer cash over Khalti due to transaction fees.
• Middle/High-income groups (YED > 1): Use Khalti more as income rises (convenience).

5. Cross Elasticity of Demand (XED)

Measures how demand for Good A changes with the price of Good B: $$\text{XED}=\frac{\%\text{ Change in Qd of A}}{\%\text{ Change in Price of B}}$$

Worked Example: Daraz vs. Amazon.in

• Price of Amazon.in goods rises by 15% → Daraz’s demand rises by 20%. $$\text{XED}=\frac{+20\%}{+15\%}=1.33(\text{Strong substitutes})$$

In the Real World

1. eSewa & Khalti (Income Elasticity)

   • Low-income users (YED < 0) avoid eSewa fees and stick to cash.
   • Middle-class users (YED > 1) adopt digital payments as income rises, boosting Khalti’s revenue by 40% in 2023.

2. NEPSE Stock Market (Price Elasticity)

   • Inelastic demand: Essential stocks (e.g., NMB Bank) see minor demand drops even if prices fall 10%.
   • Elastic demand: Luxury stocks (e.g., hotel shares) crash if prices rise, as investors switch to safer options.

3. Pathao & Taxi Services (Cross Elasticity)

   • When Pathao fares rise by 25%, traditional taxi demand rises by 30% (XED > 0, substitutes).
   • When fuel prices rise, both Pathao and taxis see inelastic demand (necessity).

Exam Tip

1. Graphs are 50% of marks: Always label:

   • Axes (Price vs. Quantity).
   • Shifts (dashed lines for non-price changes).
   • Equilibrium (P*, Q*).
   • Movements (arrows for price changes).

2. Elasticity calculations:

   • Use midpoint formula to avoid sign errors: $$\text{PED}=\frac{(Q_2-Q_1)/(Q_2+Q_1)}{(P_2-P_1)/(P_2+P_1)}$$
   • Memorize: Elastic = >1, Inelastic = <1.

3. Real-world applications:

   • Ncell/NTC: Discuss tariff hikes and inelastic demand.
   • Daraz/Amazon.in: Substitutes and cross elasticity.
   • NEPSE: Stock price reactions to economic news.

4. Common mistakes:

   • Confusing shifts (non-price) vs. movements (price).
   • Forgetting ceteris paribus in demand analysis.
   • Misclassifying goods (e.g., calling rice a luxury good).

Final Checklist Before Exam: ✅ Can you draw a demand curve with shifts? ✅ Can you calculate PED, YED, and XED from data? ✅ Can you link theory to Nepalese examples (eSewa, Ncell, Daraz)? ✅ Do you know the midpoint formula for elasticity?