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Demand Analysis
LECTURE 3
FACTORS WHICH DETERMINE THE DEMAND
OF GOODS AND SERVICES WITH SPECIAL
ATTENTION TO PRICES
Where are we?
1. FACTORS WHICH DETERMINE THE DEMAND
1.1 The impact of the price on the demand
1.2 The impact of incomes on the demand
1.3 The impact of advertising on the demand
1.4. The impact of the price and advertising of other goods on the demand for the
investigated good
2. ELASTICITY OF DEMAND
2.1. Characteristics of elasticity of demand
2.1.1. Price-elasticity of demand
2.1.1.1 Influence of the price-elasticity on sale revenue (incomes from sale)
2.1.2. Income-elasticity of demand
2.1.3. Elasticity of demand with respect to expenditures on advertisements
2.1.4. Cross-price elasticity of demand
2.1.5. Cross elasticity of demand with respect to advertisement
2.2. Calculations of elasticity of demand
2.2.1. The simplest method: quotient of the demand and price growth
2.2.2. Derivative method
3. DEMAND FUNCTIONS
3.1. Linear function – estimation and properties
3.2. Power functions - estimation and properties
Definition of the demand
Demand - quantity or value of goods and services
purchased by the buyers at a given price at a specified
time
The law of demand
The law of demand, otherwise called the Marshal
law, indicates the multidirectionality of changes in the
demand and price: an increase in the price causes a
decrease in the demand and vice versa - a decrease in
the price causes an increase in the demand
This regularity may be presented as the demand
curve - the diagram referring to the magnitude of the
demand for goods and services depending on their
price
Demand curve – scutter diagram
chart of relationship between price and demand
price
2,4
2,3
2,2
2,2
2,1
2
1,9
1,8
1,7
1,6
demand
136
151
157
157
185
199
235
246
271
294
Exceptions
It is not to all goods that the demand reacts so
strongly. Actually, there is quite an extensive group of
goods called the necessities (essential goods) for
which the demand insignificantly responds to changes
in prices. These goods comprise the basic food articles
(dairy products, grain products –bread etc.), rental
fees, and often also insurances
Rigid (stiff) demand
In theory, the rigid demand, according to its name
implication, is the demand which does not change at
all under the impact of price. In practice, however, we
do not observe such cases. We can only speak about
slightly significant or (statistically) insignificant
changes of the demand. More pertinent is the name
necessities which according to the definition is
characterized by the demand changes lower than the
price changes
Paradoxes
There are also situations when an increase in the price
causes an increase in the demand and vice versa. These
are called economic paradoxes. The best known
are the paradoxes of Giffen, Veblen and speculative
paradox
Giffen paradox
Giffen paradox - Robert Giffen noticed that in the
case of bread consumption the multitude of
requirements was increasing along with the price of
bread, contrary to the law of demand.
Generally, the Giffen paradox refers to the essential
goods or the lower order goods – inferior goods
(bread, potatoes, low quality equivalents of normal
goods - foodstuff), called the Giffen goods and
people having low incomes
Veblen paradox
Veblen paradox- refers to luxury, „snobbish” goods
(hence it is sometimes colloquially called the snob
paradox). The consumers purchase expensive, high
quality goods (sometimes aimed at their ostentatious
consumption which they treat as a sign of their high
material and social status). Veblen goods are the goods
for which there will be a fall in demand if the price falls
because of the belief that the quality has fallen
Veblen-Giffen paradox
We could say that while the Giffen goods are
purchased despite their high price, the Veblen goods
are purchased because their price is high (the goods
utility depends not only on their properties but also on
their prices which are identified with the quality).
Speculative paradox
The speculative paradox- refers to expectations as to
possible future movements of prices. In the case of an increase
in prices we are willing to buy goods if we expect further
increases in their prices (with the aim to escape from growing
prices or to sell the goods for a profit).
If the price drops and we expect some further reduction trends,
we are willing to sell our goods as early as possible, and in the
case of taking a decision to buy them we shall postpone such
decision to buy the goods for the lowest price.
The speculative paradox may be observed on capital markets,
where an increase in the shares price enhances the expectations
as to the bull market and may cause increased purchases of
shares, whereas the reduction of prices, perceived as a forecast
of approaching fall, will cause the decision to sell the shares to
protect oneself against a higher loss