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Industry and Firm Demand

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The following points highlight the six main variables affecting industry and firm demand. The variables are: 1. Autonomous Versus Derived Demand 2. Attitudes and Expectations 3. Long-run Vs. Short-run Demand 4. Product Improvement 5. Product Improvement 6. Population Changes and Shifts.

Variable # 1. Autonomous Versus Derived Demand:

The demand for a commodity is autonomous in­asmuch as it is demanded for its own sake. For ex­ample, an orange is bought because it satisfies a hu­man need. But, what about the demand for a factor like land? Is there any direct demand for land? True, the demand for land is derived from the de­mand for that in the production of which it is the main input.

In fact, consumer demand for final goods is the source of all demand for raw materials and intermediate goods. So the demand for capital goods (like textile production materials) is derived from the demand for consumption goods (say tex­tile). Similarly the demand for carpenters is de­rived from the demand for furniture’s.

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In general derived demands are found to be less elastic (more inelastic) than demand for final goods. The lower the cost of a component in propor­tion to the market price of the products, the more inelastic its demand will be. For example, the de­mand for tyres is more inelastic than the demand for finished cars.

However, a derived demand can also be subject to competition from close substitutes. For example, if the price of Dunlop tyre increases the demand for SKF tyres may go up. Thus the de­mand for a particular variety of tyre may be high.

A related point may also be noted in this con­text. Buyers of capital goods are usually experts in their own lines of business or trade. They are not much influenced by advertising and sale promotion techniques and are very much sensitive to small price differences.

Finally, J. M. Clerk has developed the famous acceleration principle to highlight the point that a small change in sales or output of a business firm may lead to an accelerated change in investment. Consider the example of a textile producer whose annual sales of cloth amount to Rs. 3 lakhs which can be produced with capital goods of Rs. 6 lakhs. His capital stock may consist of 20 machines of Rs. 30,000 each.

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One machine wears out every year and has to be replaced. Now suppose the demand for clothing goes up by 50% from 3 lakhs to Rs. 4.5 lakhs. He will now need machines of Rs. 9 lakhs which may consist of 30 machines of Rs. 30,000 each.

Moreover, one more machine will be re­quired to replace an old machine. Thus when sales go up by a modest 50% the purchase of capital goods (machines) goes up by 1000% (from 1 ma­chine to 10 + 1 = 11 machines).

This shows the ac­celerated effect on investment of a small change in consumption sales. The acceleration effect is ex­plained by the fact that “the demand for increased capacity is likely to be large in proportion to the normal replacement demand”.

Variable # 2. Attitudes and Expectations:

The demand for consumers’ durable goods like T.V. sets, radio sets or refrigerators, or producers’ durable goods like machinery, plant and equip­ment, is in general, more volatile or unstable than the demand for non-durables.

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The reason is two­fold:

(a) Durables can be stored and

(b) Its purchase or replacement can be postponed.

Thus storability of durables makes possible the expansion or contraction of inventories. So in order to forecast the demand for a durable good its pro­ducer must calculate the probability that invento­ries of the product will be increased or decreased. This, in turn, requires an evaluation of the current inventory-sales ratio and of buyer’s attitudes to­ward inventory accumulation.

The short-run price elasticity of demand for a durable good is also affected by its storability. If buyers expect the fall in the price of a product (say electric fans) to-be temporary, they will purchase beyond their needs for future use and in the process build up inventories.

The converse is also true. If the high price of a product like the V.C.R. is ex­pected to be a transitory phenomenon, people will postpone its purchase for the time being.

However, if buyers expect the fall in the price of a commodi­ty as the beginning of a trend, they will prefer to wait for still lower prices and exhaust their in­ventories. On the contrary, if the price increase of a building material like cement is viewed as the be­ginning of a trend buyers will start piling up stocks for future use.

Expectations exert a very great in­fluence on demand for durable goods because people buy such goods for future use and must make what­ever guesswork they can on the future market trends.

The demand for durable goods is also influenced by postponability of replacement. In periods of eco­nomic recession, when per capita income is low and whenever there is widespread unemployment, con­sumers usually postpone replacement of motor cars, furniture’s, houses, or even light consumer goods like pressure cookers or ovens.

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This is exactly what hap­pened during the great depression (1929-33) when net investment dropped down to zero or even be­came negative. On the contrary, in periods of ex­pected shortages as the time of war or import con­trol, replacement demand increases sharply. In 1982 most people in India imported colour T.V. sets because of the import duty concession offered to sports lovers.

Variable # 3. Long-run Vs. Short-run Demand:

We have already highlighted the point that the industry demand for a commodity is more elas­tic in the long-run than in the short run because it takes consumers some time to adjust to price chang­es. As Coyne put it, “It takes time for buyers to be­come familiar with the new price and to adjust to it and to make the required changes in their consumption habits.”

However, a temporary drop in price is unlikely to have a perceptible influence on the numerical value of price elasticity. Another reason is that some time is required to make full use of already purchased durable goods which are not to be replaced. For example, reduced bus fares in a major city like Delhi is unlikely to have its full ef­fect until some old private cars have worn out com­pletely.

Variable # 4. Product Improvement:

Changes in the quantity of an existing product or the improvement of an old product may bring about a change in its demand. For example, people in in­dustry have overreacted to the offer to buy the new 1000 c.c. Maruti car introduced by Premier automo­bile Limited in 1989.

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New products are the result of innovation. Innovation is a broad term and may re­fer to such things as development of new products, new distribution and marketing techniques, and new methods of production.

All these tend to create new substitutes for old products. The possible en­croachment of new products in old markets makes the demand for existing product uncertain. This is why in the modern world characterized by constant flow of innovation, it is difficult to predict future demand of a product with accuracy.

Variable # 5. Product Improvement:

Management does not necessarily take the de­mand for a product as given. It uses various methods to manipulate demand and thus change the shape and shift the position of the demand curve. By spending money on sales promotion and advertis­ing, a company can shift the demand curve for its product to the right and make it more inelastic.

We can cite the example of Horlicks or Dettol. Adver­tising informs a buyer about its product and its at­tributes and it can develop tastes for a product which was previously unknown to the buyer. Per­sonal selling can also raise the demand for a prod­uct as in case of textbooks.

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Advertising and other techniques of sales pro­motion are directed towards achieving a greater degree of product differentiation or a smaller de­gree of closeness of substitutes and thus establish the monopoly position of a firm in an industry.

Some firms, of course, just imitate the products of other firms and thus minimise the degree of diffe­rentiation between their products and those of their rivals, so that the imitating firms can take advantage of the resultant high elasticity of de­mand with slightly lower prices.

This mostly hap­pens in case of ladies garments and ornaments. Some firms send representatives to other firm shops just to copy the designs of leading firms.

Variable # 6. Population Changes and Shifts:

Demand is also affected by population growths and legal and illegal migration of people from one country to another. Moreover, changes in the age composition of the population bring about substan­tial changes in the demand for various products and services. If the percentage of people over 65 goes up there will be more demand for medicines and sticks.

If the percentage of people below 5 goes up there will be more demand for baby foods. If the government policy is to spread the educational op­portunities in all parts of the country there will be more demand for books. So geographic factors do affect the composition although its net effect on to­tal demand cannot be predicted with certainty.

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