Download Demand Analysis

Managerial Economics
Session 1
Demand Analysis
Professor Changqi Wu
Topics to Be Discussed

Concept of consumer demand

Elasticity of demand

Demand estimation and application
Demand
Slide 2
1. Consumer Demand
Consumer is ...
the God?
Demand
Slide 3
Individual Demand

Quantity demanded:
 Amount
of goods or services that a
consumer plans to buy in a given period

Quantity demanded and wants
 Demand
reflects not only a consumer’s
preference, but also her constraints.
Demand
Slide 4
Demand Curve
Price
($ per unit)
The demand curve slopes
downward demonstrating
that consumers are willing
to buy more at a lower price.
D
Quantity
Demand
Slide 5
Understand the Demand Curve


The height of the demand curve:

the highest price that a consumer is willing to pay
for the last unit of product

the value that a consumer attaches to that
particular unit of product diminishes.
Demand curve slopes downward, consumers
are willing to buy more when price falls

the good becomes relatively cheaper

the consumer’s real income increases
Demand
Slide 6
Income: A Non-Price Factor

Demand changes along with income at any
given price

Changes in income shift the entire demand
curve

Normal goods:


A consumer buys more when her income
increases
Inferior goods:

A consumer buys less when her income increases

Inferior goods are not low-quality goods
Demand
Slide 7
Changes in Demand

P
Income Increases

At P1, produce Q2

At P2, produce Q1

Demand Curve shifts
right

More purchased at any
price on D’ than on D
D’
D
P2
P1
Q0
Demand
Q1
Q2
Slide 8
Q
Other Non-Price Factors

Prices of related products
 substitutes
 complements

Advertising

Consumer’s tastes

Buyer’s expectation
Demand
Slide 9
Market Demand

Definition:
 Sum
of all buyers’ demand in a well
defined market

Horizontal sum of demand curves of all
individuals
Demand
Slide 10
Determining the
Market Demand Curve
Price
($)
Alan
(units)
Betty
(units)
Cindy
(units)
Market
(units)
1
6
10
16
32
2
4
8
13
25
3
2
6
10
18
4
0
4
7
11
5
0
2
4
6
Demand
Slide 11
Summing to Obtain a
Market Demand Curve
Price
5
The market demand
curve is obtained by
summing the consumer’s
demand curves
4
3
Market Demand
2
1
0
Demand
DA
5
DB
10
DC
15
20
25
30
Quantity
Slide 12
Determinants of Market Demand

Population
 Impact
of baby boomers

Demographic distribution

Income level and distribution

Market saturation
Demand
Slide 13
Population Paramid of China (1995)
Age Range
>=85
80-84
75-79
70-74
65-69
60-64
55-59
50-54
45-49
40-44
35-39
30-34
25-29
20-24
15-19
10-14
5-9
0-4
800
600
400
200
Female
Male
0
200
Number of persons
Demand
400
600
800
(in 100,000)
Slide 14
Business Demand

Demand for productive input

Demand for labor services

Market demand and firm-specific
demand curve

Demand
An individual firm may not face the entire market
demand curve
Slide 15
Market versus Industry

Industry = collection of businesses using
similar technology or input to produce goods
or services

Market = collection of products that are close
substitutes


aluminum cans and glass bottles
Substitutability
Demand
Slide 16
Buyer Surplus

Difference between the benefit a
consumer gets from a product and the
price she has paid for

Business applications
 “The
Demand
more you buy, the more you save”?!
Slide 17
Buyer Surplus
Price
($ per
ticket)
The buyer surplus
of purchasing 6 concert
tickets is the sum of the
surplus derived from
each one individually.
20
19
18
17
16
15
Consumer Surplus
6 + 5 + 4 + 3 + 2 + 1 = 21
Market Price
14
13
0
Demand
1
2
3
4
5
6
Concert Tickets
Slide 18
2. Demand Elasticities

Price elasticity of demand

Other elasticities

Time factor
Demand
Slide 19
2.1 Price Elasticity
Price elasticity of demand is...
responsiveness of the quantity demanded of a
good to a small change in its price

It measures the percentage change in the quantity
demanded for a good or service that results from a
one percent change in the price.
ep = (DQ/Q)/(DP/P) = (DQ/DP) (P/Q)

Because of the inverse relationship between price
and quantity demanded, the price elasticity of
demand is a negative number.
Slide 20
Calculating Elasticity
Price
ep = (-2/3)/(4/12) = -2
14
10
0
2
4
Quantity
Slide 21
Properties of Price Elasticity

Price elasticity is free from unit of
measurement

It falls between 0 and negative infinity
 Elastic
 Unit
demand:
ep < -1
elastic demand:ep = -1
 Inelastic
demand: ep > -1
Slide 22
Price Elasticity in Action

Price elasticity of telephone services is
estimated as ep = -0.1

Price elasticity of demand for electricity
is estimated as -0.7

Price elasticity of demand for CDs is
estimated as –1.83

What’s about price elasticity of drugs to
treat AIDS?
Slide 23
Factors Influencing Elasticity

Importance of the product to the buyer

Share in the total expenditure

Availability of a close substitute

Buyer’s prior commitment

Search costs for better prices

Separation of buyer and payee
Slide 24
Special Cases of Price Elasticity

Infinitely elastic demand

Completely inelastic demand

Unit-elastic demand

Linear demand
Slide 25
An Infinitely Elastic Demand
Price
ep = -
0
Quantity
Slide 26
A Complete Inelastic Demand
Price
eP = 0
0
Quantity
Slide 27
A Unit-Elastic Demand
Price
eP = -1
0
Quantity
Slide 28
Linear Demand Curve

The steeper the slope of a demand
curve, the less elastic the demand, all
other things constant; the flatter the
slope of a demand curve, the more
elastic the demand curve, all other
things constant

Price elasticity changes along the linear
demand curve
Slide 29
Linear Demand Curve
Price
ep = -
Elastic portion of
demand curve
ep = -1
Inelastic portion
of demand curve
ep = 0
0
Quantity
Slide 30
Price Elasticity and
Consumer Expenditure
Demand
Inelastic (ep >-1)
If Price Increases,
Expenditures:
Increase
If Price Decreases,
Expenditures:
Decrease
Unit Elastic (ep = - 1) Are unchanged
Are unchanged
Elastic (ep < -1)
Increase
Demand
Decrease
Slide 31
2.2 Other Elasticities

Income elasticity

Cross-price elasticity

Advertising elasticity
Slide 32
Income Elasticity
Income Elasticity Is ...
responsiveness of demand of a good to income
changes of consumers
% change of the demand for an item if the income
changes by 1%

Properties

luxury goods eI > 1

necessity

inferior goods eI < 0
0 < eI < 1
Slide 33
Cross-Price Elasticity
Cross-price elasticity is ...
responsiveness of demand of a good to
changes in another good’s price

Cross elasticity of demand measures
the percentage change in the quantity
demanded of one good that results from
a one percent change in the price of
another good.
Slide 34
Cross-Price Elasticity

Properties
 ec
> 0:
substitute
 ec
= 0:
independent
 ec
< 0:
complement
Demand
Slide 35
Advertising Elasticity
Advertising elasticity is...
responsiveness of demand of a good to changes
in a seller’s advertising expenditure
% change of the demand for an item if seller’s
advertising expenditure rises by 1%

Advertising elasticity of a firm is larger than
that of the market

Advertising sales ratio depends on the ratio of
adverting elasticity and price elasticity
Slide 36
2.3 Time Factor

Price elasticity of demand varies with
the amount of time consumers have in
response to a price change.
 short-run
 long-run

elasticity
elasticity
Durable and non-durable goods
Slide 37
Short-Run Versus Long-Run Elasticities

Most goods and services:


Short-run elasticity is less than long-run
elasticity. (e.g. gasoline)
Durables goods:

Demand
Short-run elasticity is greater than long-run
elasticity (e.g. automobiles)
Slide 38
Gasoline:
Short-Run and Long-Run Demand Curves
Price
DSR
People tend to
drive smaller and
more fuel efficient
cars in the long-run
Gasoline
DLR
Quantity
Demand
Slide 39
Automobiles:
Short-Run and Long-Run Demand Curves
Price
DLR
People may put
off immediate
consumption, but
eventually older cars
must be replaced.
Automobiles
DSR
Quantity
Demand
Slide 40
3. Demand Estimation

Where can we find data?

How to estimate the value of elasticity?

How can we use the elasticity
estimates?
Slide 41
Data Sources


Data type

Time series data

Cross-sectional data
Data generating methods

variables measured
 actual purchases (scanner data) versus
purchase intentions (survey)

conditions of data gathering
 uncontrolled (store data) versus controlled
experiments conjoint analysis
Slide 42
Estimation Procedure

Choice of a functional form

Decision on which variables to be included in
the estimation function

Estimation method

Regression analysis
Slide 44
Demand Data
Year Quantity (Q)
1988
1989
1990
1991
1992
1993
1994
1995
1996
Demand
4
7
8
13
16
15
19
20
22
Price (P)
24
20
17
17
10
15
12
9
5
Income(I)
10
10
10
17
17
17
20
20
20
Slide 45
Estimating Demand
Price
25
D represents demand
if only P determines
demand and then from
the data: Q=28.2-1.00P
20
15
10
D
5
0
Demand
5
10
15
20
25 Quantity
Slide 46
Estimating Demand
Adjusting for changes in income
Price
25
d1, d2, d3 represent the demand for each
income level. Including income in the
demand equation: Q = a - bP + cI or
Q = 8.08 - .49P + .81I
20
15
d1
10
d2
5
D
d3
0
Demand
5
10
15
20
25 Quantity
Slide 47
Key Learning Points

Consumer’s demand for goods and
services is influenced by many factors,
among them, price, income, advertising,
availability of alternatives, etc.

Demand curve shows the relationship
between price and quantity demanded
when non-price factors are assumed
constant; changes of non-price factors
shift the entire demand curve.
Demand
Slide 48
Key Learning Points

Elasticity of demand measures the
responsiveness of consumers’ demand
toward changes in price or in non-price
factors such as incomes of buyers.

Elasticity estimates are useful in forecasting
changes in total revenue of a firm or changes
in the quantity demanded caused by changes
of multiple factors.

Elasticity of demand can be estimated by
econometric methods.
Slide 49