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DEMAND CHAPTER 2 Chapter 2 ::: DEMAND DEFINITION OF DEMAND The desire to buy goods & services with the ability to pay The choice of the customer to buy certain goods & services & certain price level at a given time period A relationship between the price of an item & the quantity demanded CLASSIFICATION OF GOODS AND SERVICES Economic goods 2 types: Consumer goods/ final goods - That yield satisfaction to the consumer - Can be classified to: i. Durable goods: cloth, radio ii. Perishable gods: food, vegetables Capital goods - Not intended to final use, but to produce other goods - Eg: machinery, factories Types of goods Inferior goods/ giffen goods 8 DEMAND CHAPTER 2 Essential goods / necessity goods Normal goods Luxury goods LAW OF DEMAND An inverse relationship between quantity demanded & its price Cateris paribus; when P , Qd & vice versa (P & Qd are negatively related) The Individual & Market Demand 1) Individual Demand The relationship between the total quantity of a product demanded by a single individual and its price Demand Schedule – a list of the amount that a buyer is willing to buy at different prices at one particular time Demand Curve – a line curve on a graph showing the inverse relationship between the quantities demanded of a product and its prices 2) P of apple (RM) Qd of apple (unit) 1 25 2 23 3 18 4 15 5 10 6 8 Market Demand It is the horizontal summation of all the individual demand in the market at certain price level & certain time period The relationship between the total quantity of a product demanded by adding all the quantities demanded by all consumers in the market and its price Qd of apple (unit) P of apple (RM) Indiv A Indiv B Indiv C 1 25 20 26 2 23 17 22 3 18 15 16 4 15 12 14 5 10 8 11 6 8 6 7 Market 9 DEMAND CHAPTER 2 EXCEPTIONAL DEMAND The Law of Demand always holds for normal goods. Other type of goods may exhibit the opposite of what the law says. An exceptional demand curve can be regressive at higher prices(P ,Qd ) or regressive at lower prices(P ,Qd ) 1) Luxury Goods a) Regressive at higher prices - An expensive good is perceived as having higher quality & show prestige. - Status symbols goods are expensive goods that are generally bought by higher income consumers. - Example of status of symbols are gold and diamond jewellery, expensive clothing, luxury cars, and other goods that are symbols of wealth and opulence. - Status symbols goods can evoke pride and symbolize the status of the owner. - When the price of status symbol goods increase, the quantity demand will increase. - When the price of status symbol goods increases, the higher income groups will purchase these goods as a symbol of their wealth. - When the prices decrease, there will be reduced demand among the higher income level as they considered the goods to be affordable by the lower income levels. The goods are being cheaper goods. - Other example: foreign exchange market and stock market when the trading price of a stock suddenly increase, the stock will be in demand because public expect the price of stock to increase further. Therefore the public will buy more shares in hopes of accumulating higher profit. b) Expectation - If expect the P of shares to further, the DD for share now 3) Giffen Goods a) Regressive at lower prices - Giffen good is an inferior good whose demand declines as real income rises due to the decrease in price. - When the prices of inferior goods fall, the quantity demand will also fall. - This is because when the price of inferior goods falls, the real income of this consumer will rise. Therefore, consumer will purchase higher quality goods. 10 DEMAND b) Expectation - If expect the P of shares to further, the DD for share CHAPTER 2 now CHANGES IN QUANTITY DEMANDED VS CHANGE IN DEMAND - Change in Qd Movement along the demand curve eg: point A B or C B Occurs when price of a good changes but everything else remains the same eg: P1 P2 or P2 P3 Point B A = contraction (means decrease in Qd as price increase) Point B C = expansion (means increase in Qd as price decreases) - Change in DD Shift in the demand curve eg: point D0 D1 Occurs when price of good remain constant but changes in other non price factors such as population, income, price of related goods. Shift from D0 D1 increase in DD Shift from D1 D0 decrease in demand - FACTORS WHICH INFLUENCE DEMAND / DETERMINANTS OF DEMAND 1) The price of related goods a) Substitute goods - A good is a good that can be replacing or substitutes the function of another good. - An increase in the price of one good can cause an increase in the demand for its substitute. - i.e margarine and butter, palm oil and corn oil or coffee and tea. - eg: If the P Coke , Qd Pepsi (positively related) 11 DEMAND CHAPTER 2 b) Complementary goods - Complimentary goods are goods that are used together with other goods to complete the function of an object. - An increase in the price of one good will result in a decrease in the demand for its complimentary good. - i.e camera and film or car and petrol - eg: If the P car , Qd petrol (negatively related) 2) Income - The income of a household will determine consumer’s purchasing power and consumer’s spending patterns - When consumer’s purchasing power increase, the demand for goods will increase respectively. - The effect of income on the demand of goods is determined by the types of goods like normal goods and inferior goods. - When a consumer’s income increases, the consumers will increase their expenditure. This means that although there are no changes in the price of goods, the quantity demand for goods will increase respectively with the increase in income. (vice versa) a) Normal goods - There is a positive relationship between consumer’s income and the quantity demand for normal goods. - If income , DD for normal goods b) Inferior goods - Inferior goods or giffen goods are normally of poor quantity and they constitute a large part of the poor man’s expenditure. - There is an inverse relationship between consumer’s income and quantity demand for inferior goods. - If income , DD for inferior goods 12 DEMAND CHAPTER 2 3) Taste & preference - Taste is the preference of a household for a particular good. Taste change over time and is influenced by latest trends in fashions, health awareness, the influence of advertising, and sales promotions. - If a good is in fashion or to a consumer’s taste, there will be a higher demand and lead shift to the right. - However, when consumers do not like a good, demand for the good will be lower and shift to the left. - Eg: nowadays, the taste for skinny jeans is being more favorable than boot cut jeans. 4) Size of population - The number of occupants in an area will also affect demand. When the population of an area increases, the general demand for goods will increase and shift right. - Increase in total population, DD for goods & services will be greater. - eg: increase in population in Segamat, DD for houses & bus services will be increase. 5) Expectation about future prices (speculation) - if consumer believe that the price of a good will rise in a future, consumers will buy more of that good. This will cause an increased for the good. (vice versa) - The higher the expected future price of a good, today’s demand for the good will be larger - eg: If price of petrol will next week, DD for petrol today will 6) Government policies - Government policies can influence demand through taxation and subsidies. - When the government increase taxation rates on imported goods, there will be a reduced demand for imported goods due to the increased in prices. (vice versa) - When the government subsidizes the production of a good, the demand for the good will increase. This is because the prices of the good will decrease due to the subsidy. 13 DEMAND CHAPTER 2 7) Advertisements - Advertising in electronic and print media can attract customers to purchase goods such as energy drinks and camera phones. - Advertised goods normally have higher DD because of awareness - advertisement will attract people about the goods & services 8) Festive seasons & climate - During festive seasons, different product will be demanded & higher DD for that particular products. - i.e monsoon season, festivals season, and school seasons. - Eg: during festivals, the demand for food, clothing and transparent will increase n shift to right. INTER- RELATED DEMAND 1) Joint Demand - It applies to the demands for complementary goods. - The effect of change in the price for complementary goods is –ve. - eg: toothbrush & toothpaste, pen & ink, cars & petrol P pen , Q ink 2) Competitive Demand - It applies to the demands for substitute goods. - The effect of change in the price for substitute goods is +ve. - eg: butter & margarine,Pepsi Cola & Coca Cola,Toyota car & Proton Wira P Toyota , Q Wira 3) Derived Demand - When the DD of good increases, the DD of the factor of production/input to produce the goods will also increase - eg: DD for houses , DD for bricks, cement, tiles 4) Composite Demand - Refers to multipurpose products - eg:rubber is used to make shoes, tyres, ball etc ELASTICITY OF DEMAND Has same meaning as sensitivity/ responsiveness Can be used to quantify the response in one variable when another variable changes 3 types of elasticity: 1) Price elasticity (єp) 2) Income elasticity (єy) 3) Cross elasticity (єx) 1) Price elasticity (єp) - Def: To measure the responsiveness of quantity demanded due to the change in its own price - Formula: єp = % ∆ Qd %∆P = %change in Qd %change in price = Q1 – Q0 X P0 Q0 P1 – P0 Where: Q1=new quantity 14 DEMAND CHAPTER 2 Q0=original quantity P1=new price P0=original price Degree Elastic Description Value of coefficient Slope of DD curve %∆Qd>%∆P 1< єp <∞ Inelastic %∆Qd<%∆P 0< єp <1 Unitary Elastic %∆Qd=%∆P єp =1 Perfectly Elastic Any increase in P will cause the Qd to be 0. P is fixed єp = ∞ 15 DEMAND Perfectly Inelastic CHAPTER 2 Any change in P will not change the Qd. Qd is fixed єp = 0 Determinants of Price Elasticity of Demand 1) Availability of substitutes - DD is more elastic when more substitutes for the product are available - eg: soft drink has many substitutes - elastic DD (Pepsi Cola, Coca Cola, Mirinda, Sprite etc) - Necessity good such as rice (less substitutes) has an inelastic demand 2) Relative importance of the good in the budget - DD is more elastic when the item takes a more significant portion of the consumer’s budget - eg: cars – the purchase of a car takes a large amount of our income, therefore a small increase in the prices of cars will have a very large effect on the demand for cars - Some goods (small fraction of the income) such as pencil, chewing gum, salt is inelastic 3) The importance of the goods - The demand for necessity goods is inelastic- eg: DD for rice is elastic because it is important to us (if there is a great increase in price for rice, the DD will not change very much) 4) Time dimension - Short run the elasticity of DD is inelastic - Long run DD more elastic/responsive because consumers can make adjustments to their DD & have time to find other substitutes 5) Income level - Higher income inelastic DD because being richer they are less sensitive to price changes - Lower income more elastic 6) Habits - DD is inelastic when the item is consumed habitually - eg: smokers need to smoke no matter how expensive cigarettes are 2) Income elasticity (єy) - Def: To measure the responsiveness of quantity demanded due to the change in income - Formula: єy = % ∆ Qd = %change in Qd %∆Y %change in income = Q 1 – Q0 X Y0 16 DEMAND Q0 CHAPTER 2 Y1 – Y0 Where: Q1= new quantity Q0= original quantity Y1= new income Y0= original income Types of good Value of Coeficient Positive ЄY>1 Luxury goods (antique furniture) Positive ЄY≤1 Normal goods (cloth, shoes) Zero ЄY=0 Necessity goods (rice, fish) Negative Inferior goods (low grade rice) Type Description Y , big Y ,small Y in Qd in Qd , no change in Qd Y , Qd 3) Cross elasticity (єx) - Def: To measure the responsiveness of quantity demanded due to the change in the prices of other goods - Formula: єPQ = % ∆QQ % ∆PP = %change in Qd of good Q %change in P of good P = QQ1-QQ0 X QQ0 PP0 PP1-PP0 Where: QQ1=new quantity of good Q QQ0=original quantity of good Q PP1=new price of good P PP0=original price of good P Relationship between goods Value of Coefficient Relationship Positive Substitute Negative Complementary Description Py ,Qy ; Qx Py ,Qy ;Qx 17 DEMAND Zero CHAPTER 2 Py ,Qy ; No change inQx Not related Price elasticity and total revenue TR = P X Q Whether TR / as the price increases depends on the elasticity of demand Effect to TR Coefficient of elasticity Terminology Description Єd>1 Elastic demand %∆Qd>%∆P Єd=1 Unitary Elasticity of demand %∆Qd=%∆P Inelastic demand %∆Qd<%∆P Єd<1 (P P P TR TR X Qd ) (P TR X Qd ) TR (P X Qd TR ) (P X Qd ) (P (P X Qd TR X Qd ) ) 18