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Demand
• Demand for a good or service is defined as
quantities of a good or service that people are
ready (willing and able) to buy at various
prices within some given time period, other
factors besides price held constant.
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Demand Function
• The demand for a commodity arises from the
consumers’ willingness and ability to purchase
the commodity. Consumer demand theory
postulates that the quantity demanded of a
commodity is a function of / or depends on the
price of the commodity, the consumers’
income, the price of related commodities, and
the tastes of the consumer.
• Qd = f(p){Y,Pr , T, N}
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Change in Quantity Demanded
Price
An increase in price
causes a decrease in
quantity demanded.
P1
P0
Q1
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Q0
Quantity
4
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Change in Quantity Demanded
Price
A decrease in price
causes an increase in
quantity demanded.
P0
P1
Q0
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Q1
Quantity
5
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Changes in demand
• Changes in price result in changes in the
quantity demanded.
– This is shown as movement along the demand
curve.
• Changes in nonprice determinants result in
changes in demand.
– This is shown as a shift in the demand curve.
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Changes in demand
• Nonprice determinants of demand
– Tastes and preferences
– Income
– Prices of related products
– Future expectations
– Number of buyers
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Changes in demand
•
•
•
•
•
•
Change in Buyers’ Tastes
-Today’ consumer purchases leaner meats compared to old generations
-due to the level of blood cholesterol and body weight
Change in Buyers’ Incomes
– Normal Goods
i.e., shoes, travel, automobiles, education
– Inferior Goods
– i.e., potatoes, salt
Change in the Number of Buyers
Change in the Price of Related Goods
– Substitute Goods
i.e., Carrots can be replaced by cabbage
– Complementary Goods
i.e., cars and gasoline or electric stove and electricity.
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Change in Demand
An increase in demand
refers to a rightward shift
in the market demand
curve.
Price
P0
Q0
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Q1
Quantity
9
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Change in Demand
A decrease in demand
refers to a leftward shift
in the market demand
curve.
Price
P0
Q1
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Q0
Quantity
10
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Mathematically
Qdx= f(Px, I, Py, N,T)
• QdX/PX < 0
• QdX/I > 0 if a good is normal
• QdX/I < 0 if a good is inferior
• QdX/PY > 0 if X and Y are substitutes
• QdX/PY < 0 if X and Y are complements
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Related concepts

The increase in Qx when Px falls occurs because
in consumption, the individual consumer
substitutes commodity x for other commodities
which are now relatively expensive. This is called
the substitution effect.

In addition, when Px falls, a consumer can
purchase more of x with a given amount of money
(i.e., the consumer’s real income increases). This
is called the income effect.
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To remember..
• Band wagon effect: “ to keep up with the
Joneses” “Me too”
• Snob Effect:
“Me only”
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Using elasticity in managerial
decision making
• Controllable factors
–
–
–
–
Setting the price of its product
Expenditures on advertisement
Quality of its product
Customer service
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Using elasticity in managerial
making decision…. continued
• Uncontrollable factors
– Level and growth of consumer income
– Competitor price decisions
– Competitors expenditures on advertisement
– Competitor’s Product quality and customer service
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Price Elasticity of Demand/Demand
sensitivity Analysis
• Price Elasticity of demand is the measure of the
response of the change in the quantity demanded due
to the change in the price of the product.
Ep = ΔQd × P
ΔP
Q
• Decision: If demand for a product is price inelastic, the
firm would not decrease the price of the product, by
doing so the firm would decrease its profit.
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Mathematically
EP
Q / Q
Q P



P / P
P Q
Linear Function
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P
EP  a1 
Q
17
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Price Elasticity of Demand- Example
Market

Px

8
A
6
4
2
0
0

B
C

D
E
F

G

200
400
600
Qdx
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800
1000 1200

Find Ep at point A, B, C
and G
Ep=(ΔQ/ ΔP) (P/Q)
At point A, Ep=(0-200/
6-5) (6/0)
Ep=-200 (6/0)= indefinite
At point B, Ep= (200400/5-4) (5/200)=-5
At point C, Ep=(400600/4-3) (4/400)=-2
At point G =??
18
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MR and TR based on Elasticity- Example
P
Q
Ep
TR=P.Q
MR=DTR/DQ
(1)
(2)
(3)
(4)
(5)
$6
0
-indefinite
$0
-
5
200
-5
1,000
5
4
400
-2
1,600
3
3
600
-1
1,800
1
2
800
-1/2
1,600
-1
1
1,000
-1/5
1,000
-3
0
1,200
0
0
-5
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19
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Graphically Showing Elasticities and MR-TR
MR>0 MR<0
EP  1 E  1
TR
P
0
600
EP  1 MR=0
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1200
QX
20
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Graphically Showing Elasticities and MR-TR
PX
6
EP  1
EP  1
EP  1
0
600
1200
QX
MR
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X
21
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Price Elasticity & Firm's Total
Revenue
P
Q
6
5
4
3
2
1
0
0
100
200
300
400
500
600
Ep
∞
5
2
1
0.5
0.2
0
TR=P.Q
$0
500
800
900
800
500
0
Situation
Perfectly Elastic
More Elastic
More Elastic
Unitary Elastic
Less Elastic
Less Elastic
inelastic
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Price elasticity, total revenue, and
Demand
F
TR
900
TR
P ($)
6
5
600
300
E
P
Qd
>1
4
E
3
2
P
=1
E
P
<1
1
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0
300
600
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Reference page 138
• Case study 4-3 (Price elasticity of Demand)
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Income Elasticity of Demand
Income Elasticity of Demand measure the response of the change-in-quantitydemanded due to the change-in-income of the people.
Ey = ΔQd × Y
ΔY
Q
Income elasticity of demand suggests the growth potential of a market. It also shows
the nature of good.
If Ey = 0
the good is income inelastic and has no
growth.
potential for the market
If Ey= +ve
the good is a normal good and is income
elastic
If Ey= -ve
the good is an inferior good and is income
elastic
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Income Elasticity of Demand
Normal Good
E
I
 0
Luxuries Good
E
I
 1
Inferior Good
EI  0
Necessities Good
0 <I E < 1
26
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Income Elasticity of Demand

Point Definition

Linear Function
EI  a3 
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I
Q
27
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Using Income Elasticity in managerial
making decision…. continued
• Decision:
• If income elasticity of demand is very low for the
firm’s product is Negative, management must
know that firm will not benefit from the rising
incomes of the people and may want to improve
its product or move into new product line with
more income elasticity of demand.
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Reference page 140
• Case study 4-4 (income elasticity of demand)
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Cross Elasticity of Demand
Cross Elasticity of Demand measures the response of the change-in-quantity demanded of
a product due to change-in-the price of competitor’s product.
ECr = ΔQa × Pb
ΔPb
Qa
Cross Elasticity of demand shows the rivalry of the product.
Ecr= +ve
the good will be substitute good
Ecr=-ve
the good will be complimentary good
Ecr= 0 the goods are uncorrelated.
For Example,
Ppepesi increase  Qcoke increases
(Substitute good)
Pcar increase  Qpetrol decreases
(Complimentary Good)
Pbutter increase  Qbooks remains the same (Uncorrelated goods)
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Cross-Price Elasticity of Demand
Point Definition
Linear Function
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QX / QX QX PY
E XY 


PY / PY
PY QX
E XY
PY
 a4 
QX
31
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Cross-Price Elasticity of Demand
Substitutes
Complements
EXY  0
EXY  0
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32
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Using Cross Elasticity in managerial
making decision…. continued
• Decision:
• If the firm estimated that cross elasticity of
demand for its product with respect to the price
of competitor’s product is very high. It will be
good to quickly respond to the competitor price
reduction ,otherwise, the firm would lose a great
deal of its sale.
• However the firm would think twice before
lowering its price for fear of starting a price war.
• For reference: read case application 3-7 p#117,
5th edi. “demand elasiticities for beverages in
USA”
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Commodity X
Commodity Y
Substitute Goods:
Natural Gas
Coke
Tea
Electricity
Pepsi
Coffee
Complementary Goods:
Car
Petrol
Mobile
SIM Card
Pen
Ink
EXY
0.80
0.40
0.29
-0.50
-0.72
-0.87
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Commodity X
EXY
Commodity Y
Substitute Goods:
McIntosh apple
Apples
Apples
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Golden delicious apples
Apple Juice
Energy Drinks
0.80
0.50
0.10
Case Study 4-5 page 143
• 1) Cross elasticity of demand
• Case study 4-6 page # 147
• Price ,income and cross elasticities
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In case of substitute goods
Price of Tea ($)
Q.D of Coffee
P0Tea
10
Q0Cofee 100
P1Tea
40
Q1Cofee 200
Ed=?
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In case of complementary
goods
Price of Petrol
Per liters ($)
Q.D of Cars
P0Petrol
10
Q0Car
100
P1Petrol
40
Q1Car
20
Ed=?
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Advertising Elasticity of
Demand
Advertising Elasticity of Demand measure the response of the changein-quantity-demanded due to the change-in-Advertising expenditures.
EA = ΔQd × A
ΔA
Q
Decision:
If elasticity of sale with respect to advertising is positive and higher
than for its expenditures on product quality and customer service then
firm must concentrate more on advertising rather than on product
quality and customer service.
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Using Elasticises In Managerial
Decision Making-Example
A firm selling coffee brand X and estimated
relevant demand regression as follows:
 Qx=1.5-3.0 Px+0.8 I+2.0 Py-0.6 Ps+1.2 A
 Qx is sales of coffee brand X, I is disposable
income, Py is price of competitive coffee
brand, Ps is price of sugar and A is advertising
expenditures for coffee brand X.
 Suppose: Px=$2, I=$2.5, Py=$1.80, Ps=$0.50
and A=$1

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Using Elasticities In Managerial Decision Making
Example page 145

Calculate Qx and the elasticities of sales with respect to each variable in
the relevant demand function

Qx=1.5-3.0(2)…1.2(1)=2 mn pounds coffee

Calculate the elasticities of the demand for coffee brand X

Ep=-3(2/2)=-3,Ei=0.8(2.5/2)=1, Exy=2(1.8/2)
Exs=-0.6(0.5/2)=-0.15, Ea=1.2(1/2)=0.6
RECALL the Formulae


EP
P
 a1 
Q
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E XY  a4 
PY
QX
EI
I
 a3 
Q
41
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Using Elasticises In Managerial Decision MakingExample





Next year, the firm would like to increase Px by 5%, A by
12%, I by 4%, and Py 7% whereas Ps fall by 8%.
Determine sales of coffee brand X in the next year.
Qxx=Qx+Qx(DPx/Px)Ep……+Qx(DA/A)Ea
Qxx=2+2(5%)(-3)…..+2(5%)(0.6)
Qxx=2.2 or 2,200,000 pounds
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42
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Question
Given the demand for beef in the country.
Qd= 4850 – 5Pb + 1.5Pc + 0.1Y
Y = National Income
Pb = Price of Beef
Pc = Price of Chicken
= 10,000
= 200
=100
Find the Following Elasticities of Demand for Beef in the
Country:
a. Price Elasticity of Demand
b. Income Elasticity of Demand
c. Cross Elasticity of Demand.
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Thanks
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The important steps by using Elasticities

The analysis of the forces or variables that affect on demand and reliable
estimates of their quantitative effect on sales (elasticities) are essential in
order for firm to make best operating decisions in shor-run and to plan for
its growth in the long-run.
 The firms can use the elasticities of demand of the variables under their
controls to find out best policies as well as to maximize their profits.
 If the demand for the firm’s product is price inelastic, the firm will want to
increase the product price since that would increase its total revenue and
reduce its total cost.
 If the elasticity of the firm’s sales wrt the variable beyod its control or If
the cross-price elasticity of demand for the firm’s product is very high, the
firm will need to respond quickly to a competitor’s price reduction
otherwise losing a great deal of its sales.
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The important steps by using Elasticities
•
The size of the price elasticity of demand is larger, the closer and
the greater is the number of available substitutes for the
commodity. For example, sugar is more price elastic than table salt
(e.g. honey)
• In general, the greater is its price elasticity of demand, the greater
will be the number of substitutes
• For a given price change, the quantity response is likely to be
much larger in the long run than short run so the price elasticity
odf demand is likely to be much greater in the long run than short
run .
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The demand faced by a firm (cont….)
• Following forces effect the demand of a firm.
• Own Price of the product
• Consumer income & taste
• Price of related goods
• Numbers of consumers in market
• Level of Advertisement and promotional policies
• Availability of credit in the country
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Mathematically….
QD=F(P, Y , Pr ,T, A, etc)
Where as
Qd=Quantity demand of commodity X
P=Price of commodity X
Y= Income of the household
Pr=Price of related goods (substitutes or complementary)
T=Taste of consumer
A= Advertising
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Results
• QdX/I > 0 if a good
is normal
• QdX/I < 0 if a good
is inferior
• QdX/PY > 0 if X and
Y are substitutes
• QdX/PY < 0 if X and
Y are complements
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Substitutes
EXY  0
Complements
EXY  0
Normal Good
E
I
 0
Luxuries Good
E
I
 1
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Inferior Good
EI  0
Necessities Good
0 <I E < 1
• SALES = [(number of print ads) x .34] +
[(number of radio ads) x .42]," which allows
you to forecast SALES based on easy-tovisualize predictors
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