Do soaring price and mounting demand in Indian gold market speak of a paradox? Submitted on: 30/07/2010 Case study ABSTRACT This case clearly and systematically explains the causes and effect of increasing demand of gold in India and helps to analyse the changes in demand curve. Gold has always been a driving force in history. India is the largest gold consumer country accounting for 25% of the total demand of gold. Our aim is to analyse various determinant that operate demand. Generally, it is seen that festivals like Diwali, Akshaytritya and marriages increases the demand of gold.
This case present the condition where in 2008, people switched off their funds to gold as global economy was under recession. This condition increased the demand for gold and kept the price of gold relatively high as well. Hence, it presented the paradox to soaring price and mounting investment demand for gold. Whereas,this condition was not seen in the case of jewellery. The demand of gold jewellery started falling when the prices were high. Tables and Figures For reference TABLE 1| | | Year| Price of gold| Quantity of gold demanded| 1991| 8518| 271| 1992| 9629| 371| 993| 11481| 314| 1994| 12222| 428| 1995| 12962| 514| 1996| 13333| 556| 1997| 12222| 771| 1998| 12000| 871| 1999| 12222| 813| 2000| 12592| 813| 2001| 13703| 800| 2002| 15925| 628| 2003| 17777| 600| 2004| 19259| 685| 2005| 20370| 813| Study of demand in case of Gold Overview Demand is willingness to purchase. There are various factors which are considered for analysing the demand for a particular commodity. These factors are known as Determinants of Demand. The factors are: 1. Price factor 2. Non Price factors Demand is the function of price and non price factors.Order now
Qd= f( Price factor, non price factor) Law of demand The relationship between Price and quantity is represented in a graph which shows Demand curve provided that we keep all other non price factors constant. The inverse price quantity relationship indicating that a greater commodity is demanded at lower prices and a smaller quantity at higher prices is called as Law of Demand. Analysis Case 1: Paradox to law of Demand Facts for investment based demand of gold In 2005 gold prices went up and also the demand increased. (Refer Table 1) Reasons: 1.
Future Value: The higher goes the price for gold, the stronger became the conviction of Indians that gold is the best way to enhance one’s wealth. 2. Geopolitical uncertainty: This conviction got even stronger during the recession. Everyone switched their investments to gold thus making the demand for gold go up. 3. Inflation: In 2009, the demand for gold increased as the investors expected it to raise more which in turn increased the gold prices. 4. Portfolio Diversification: It is observed that Gold has a negative correlation with stock market and therefore it is seen as an inflation hedge.
Demand curve (keeping non price factor constant) This positive relationship between price and quantity demanded is mainly due to non price factors which are explained in detail in later section. (Refer Influence of non price factors) Case2: Demand for jewellery based investment * In October 2008 the demand went up because the prices for gold went down. * In 2007 the prices for gold went up and so the demand for gold jewellery decreased. * During recession where the investment based demand was increased, the jewellery based demand saw a huge dip because of the high prices. In Feb. 2009 platinum was less than half the price it was in 2008. So people started buying platinum instead of gold, as the gold prices were still rising. This substitution effect increased the market share for platinum. Demand curve of gold jewellery (Fig: Change in quantity demanded) Influence of non price factors There are many other factors apart from Price factor. These are called as non price factor. These include: 1. Income of the consumer: Rise in income lead to more demand of gold in India (reported 2004, Refer “The Role of gold in India”). . Price of the related goods: If the price of the related increases then price of the gold will also increase. 3. Consumers’ taste and preferences: Gold is a conspicuous commodity. People demand it as they prefer it. 4. Festivals and marriages: Akshayatritya and Diwali are considered good for buying the gold. And in Hindu culture, Gold is given as a gift to daughters so the demand increases. 5. Population: No. of people buying the commodity also define the demand of the commodity. Larger no. shows high demand for a particular commodity. 6.
Expected Future prices: People believe that there is a possibility of rising the price of gold in coming years so they demand it more and price rises. Etc. Influence of non price factors on demand curve Demand curve for gold (when non price factors are included) (Fig: Change in demand) Whenever there is an increase or intervention of non price factor such as income, inflation, government policies, relative good, population, expectation for future value, festival, taste and preferences of customer then there is a whole shift in the demand curve.
Effect of supply on Price and demand of gold The direct relationship between the price and quantity indicating that rise in price will lead to rise in supply and rise of demand will also lead to increase in supply. This phenomenon is called law of supply. It sometimes became limiting and hence the price will increase. The point where supply curve and demand curve intersect is known as market equilibrium. It is a point where consumers are ready to buy and supplier is ready to sell. In the above curve, G1s is a supply curve and G1d and G2d are demand curve.
The Demand is showed to increase by non price factor and supply is assumed to be constant for few years. This shows that though supply has not changed but due to shift in demand graph, the market equilibrium is now maintained at point 2 rather than point 1. This increases the price as well as demand. On the other hand, when the demand is kept constant and if the supply reduces then the line G1s shifts towards the left and increases the price but reduces the demand. Supply constraint in the case of gold:
In the case of gold market, the supply of the gold reduced from 2573 tonnes in 2000 to 2444 tonnes in 2005. The supply curve shifted towards left. On the other hand the demand curve shifted toward right due to non price factor over the years (refer graph). This shift on both curves raised the market equilibrium to a point where price is high along with the demand. Conclusion: Hence the demand curve of gold initially looked inverted but, now we analyse that it follows a general law of supply and demand because of the fact that non price factor affects the demand and hence the price.