Download Analysis of demand

University of Technology
Managerial Economics
Riad Sultan
Applied Economics
Lecture in demand and consumer theory
Contact: +2307677377, +2304037882
[email protected]
[email protected]
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Managerial Economics: Analysis of demand
Readings: Dwivedi, D. N (2008) Managerial Economics,
Chapter 6,7,8
The manager’s playing field: the market
The market for a product works on certain
market principles, the laws that govern the
working of the market system
Fundamental laws of the market: the laws of
demand and supply
Conclusion: determine the price of the product
2
Market system
Two forces of the market: demand and supply
Market: goods and services are exchanged,
bought and sold
: where buyers and sellers interact to
determine the price of a good and quantity
Sellers and buyers: individuals, firms, factories,
dealers and agents
3
The Demand side of the market
Demand: refers to all
consumers and the price that
they are willing to pay and able
to pay for buying a certain
quantity of the product during a
period of time
4
The Law of Demand
When price goes up, quantity demanded
falls
Price is the most important determinant of
demand
Demand schedule: presentation of
quantity demanded at different prices
5
The Law of Demand
Price (Rs)
Quantity (units
8
8
6
15
4
30
3
40
2
55
1
80
6
The Demand Schedule (Curve)
9
8
7
Price
6
5
4
3
2
1
0
0
20
40
60
80
100
Quantity
7
Factors affecting demand
Consumer’s income
Price of the substitutes and
complementary goods
Consumer’s taste and preferences
Advertisement
8
Shift in the demand schedule
9
8
7
6
5
Qold
4
Qnew
3
2
1
0
0
50
100
150
9
The supple side of the market
Supply means the quantity of a commodity that
its producers or sellers offer for sale at a
given price
The law of supply: as price increases, supply
will also rise
10
Supply schedule
Price (Rs)
Quantity (units
8
95
6
80
4
55
3
40
2
25
1
5
11
The supply schedule
9
8
7
6
5
4
3
2
1
0
0
20
40
60
80
100
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The Market
Price (Rs)
Demand
Supply
8
8
95
6
15
80
4
30
55
3
40
40
2
55
25
1
80
5
Calculate
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Consumer theory and the
Individual Demand
•
Three crucial features of demand:
1. Desire to have the good;
•
The good confers utility to the consumer
2. Willingness to pay;
•
There is a willingness to pay to acquire the
right to consume the good;
3. Ability to pay for that good;
•
The consumer has the resource to purchase
the good.
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Individual Demand and Price
What is the relationship between the
individual’s demand for a product and the
price of that product?
To answer this question, scholars in
economics have constructed a theory
‘Consumer Theory’
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Consumer Theory
Starting point of the theory: what are the
characteristics of a human
For the economist, human refers to
economic agent
What is an economic agent?
Someone who is rational!!
What is rationality? The means –ends
relationship
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Economic Agents
Assume rational
Assume to be self-interest
Maximise utility
Choices are transitive
Non-satiation point
Ability to compare between different
bundle of goods (completeness)
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Building a theory of individual
demand -Consumer theory
Two requirements:
– study constraint: ability to pay
– Study preference: willingness to pay
A budget constraint
–
–
–
–
–
Income=m
Price of good X = Px
Price of good Y = Py
Quantity of X = Qx
Quantity of Y = Qy
The budget constraint: PxQx + PyQy = m
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Budget constraint: graphical
illustration
Good Y, Qy
Inability to buy
Ability to buy
When price of X falls
When price of X rises
Good X, Qx
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Desire and willingness to buy:
Consumer Preference
Good Y, Qy
Better off
The Consumer is indifferent
Worst off
Good X, Qx
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Desire and willingness to buy:
Consumer Preference
Good Y, Qy
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Ability to pay + Desire + willingness
to pay
Good Y, Qy
Equilibrium
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Good Y, Qy
A
B
Good X, Qx
A
P1
B
P0
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Conclusion: Take away point
Movement from A to B derives the
demand curve
The movement means a reallocation of
resource and choice
– It is made up of two effects:
1. income effect: when price falls, the consumer
has more purchasing power
2. Substitution effect: when price falls, the product
becomes cheaper, the consumer consumes
more of it and less of the other
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Demand for a product
When price falls:
– Substitution effect: the consumer consumes
more
– Income effect:
if the good is a normal good, consumer will
consume more
If the good is inferior good, the consumer will
consume less
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Analysis of Market Demand
Market demand can be defined as the sum
of individuals demands for a product at a
price per unit of time.
The aggregate of individuals demands for
a product is called market demand for the
product
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The derivation of market demand
Adding up individual demand at different
prices
Summing up individual demand functions
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Market demand curve
Price of X
25
20
15
10
5
0
A
0
5
10
15
20
25
B
0
0
5
10
15
20
C
0
0
0
5
10
15
Market demand
0
5
15
30
45
60
28
The derivation of market demand
Market demand curve
30
25
A
Price
20
B
15
C
10
Market
5
0
0
20
40
60
80
Quantity
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Mathematical approach
A’s demand: Da = 100 – 10Px
B’s demand: Db = 75 – 7.5Px
C’s demand: Dc = 50 – 5Px
Market demand curve: D = (10010Px)+(75-7.5Px)+(50-5Px)= 225-22.5Px
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Kinds of demand
Individual demand
Market demand
What is more important for the business
– Demand for firm’s product
– Demand for the industry’s product
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Industry’s and firm’s demand
Aggregate demand of all firms is called the
industry demand function
firm’s demand: how the industry demand
is shared??
– One leader and many followers
– Equal sharing and many firms
– Equal sharing but few firms
– One firm
32
Autonomous or direct demand function
Derived demand
Durable goods demand: create
replacement demand, due to depreciation
Non-durable goods demand: satisfaction is
exhausted from a single use
– all food items
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Short run demand: fashion, seasonal,
inferior,
Long run demand: consumer and producer
goods
34
Take away points
Determinants of market demand
– Price of the product
– Price of the related goods
Substitute
Complements
–
–
–
–
–
–
–
–
–
–
–
–
Consumer’s income
Essential consumer goods
Inferior goods
Normal goods
Luxury and prestige goods
Consumer’s taste and preference
Advertisement expenditure
Consumers’ expectations
Demonstration effects
Consumer-credit facility
Population of the Country
Distribution of National income
35
Analysis of demand
Linear demand function
Non-linear demand function
Elasticities of demand
Arc elasticities
Point elasticities
Price elasticity and marginal revenue
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Demand function
Dx = 100 – 5Px
– When price = 0, Dx = 100
– When price =10, Dx = 50
– When price =20, Dx = 0
– Such demand function is called LINEAR
DEMAND FUNCTION
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Non Linear: Dx = 10(Px)-3
Dynamic or long run demand function
: Qx = 1.0 - 2.0 Px +1.5 I + 0.8 Py – 3.0 Pm + 1.0 A
Qx = Sales of corn flakes, in millions of 10 ouces boxes
Px = the price of cornflakes, in rupees
I = personal disposal income
Py = price of competitive brand of cornflakes
Pm = price of milk
A = advertising expenditures
Dx  10(Px) d
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Exercise
think of a product
Identify the determinants of demand for
the your product
– E.g. tomatoes, restaurants meals, glassware,
taxi service, furniture, housing, alcohol,
movies, foreign air travel, shoes, auto repair,
medical insurance, gasoline, owner occupied
housing
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Application
An economic consultant for X Corp. recently provided the firm’s
marketing manager with this estimate of the demand function
for the firm’s product:
Qx = 12,000 – 3Px + 4Py – 1M +2Ax
where Qx represents the amount consumed of good X, Px is the
price of good X, Py is the price of good Y, M is income, and Ax
represents the amount of advertising spent on good X. Suppose
good X sells for Rs200 per unit, good Y sells for Rs15 per unit,
the company utilises 2,000 units of advertising, and consumer
income is Rs10,000. How much of good X do consumers
purchase? Are goods X and Y substitutes or complements? Is
good X a normal or an inferior good?
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Application
You are the manager of a chain of computer
stores. The state has recently passed a twotier program designed to further enhance the
computer industry position. The legislation
provides increased funding for computer
education in primary and secondary schools,
as well as tax breaks for firms that develop
computer software. As a result, what do you
predict will happen to the equilibrium price
and quantity of software?
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Review Question
1.
2.
3.
4.
5.
Distinguish between individual and market demand for
a product. Market demand is the main concern of
business managers. Why should business managers
then study individual demand curve?
What are main determinants of market demand for a
commodity?
How do the changes in the following factors affect the
demand for a commodity?
Price,
Income
Price of substitute
advertisement
Population
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