Analysis of Demand

Analysis of Demand

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Meaning Desire for a commodity backed by the ability and willingness to pay for

it.A want with three attribute1. Desire to buy2. Willingness to pay3. Ability to pay

Becomes effective demand

A meaning full statement regarding the demand for a commodity should contain

• The quantity demanded • Price• Time• Place

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What factor affect the demand for a commodity

• Price of the commodity• Income of the consumer• Price of related goods (substitute & complementary)• Fashion, tastes and preferences of consumers• Number of consumers• Future expectation of change in price• Seasonal goods• Credit facility• Advertisement of the product• Demonstration effect• Distribution pattern of national income 8/14/2013 3

Demand function

scommoditieother of price ....,fashion F

preference P tastesT

xcommodity of price Pxcommodity for Demand

....),,,,,,(

21

x

21

=======

PP

DPPFPTYPfD

x

xx

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Law of demand

Other things remaining the same, demand will be more when price is less and it will be less when price is more.

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Demand schedule and curve

Price (Rs.) Quantity demand (units)

2 25

4 20

6 15

8 10

10 5

P

P1

Q Q1

D

PRICE

Quantity Demand8/14/2013 6

Exceptions of the law of demand

• Inferior goods (Giffen goods)• Expectations of changes in the price in

future• Fashion• Possibility of war• Ignorance• Snobbery : status symbol ( snob effect)

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Why does a demand curve slope downwards to the right

• Law of diminishing marginal utility• Income effect• Substitution effect• Many uses of a commodity• Band wagon effect

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Increase and decrease in demand

Increase in demand

Price Shift in demand curve upward

Quantity demand

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Increase and decrease in demand

Decrease In demand

Price Shift in demand curve downwards

Quantity demand

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Increase and decrease in demand

Increase in demand

Decrease In demand

Price Shift in demand curve

Quantity demand

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Extension and contraction in demand

extension

Price

Quantity demand

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Extension and contraction in demand

contraction

Price

Quantity demand

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Extension and contraction in demand

contraction

extension

MovementAlong The demand curve

Price

Quantity demand

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Market demand schedule and curve

Price Demand of A Demand of B Market demand (A+B)

2 25 20 454 20 18 386 15 14 298 10 10 2010 5 6 11

15

PRICE

Quantity demand

A B

Market demandA+B

PRICE

PRICE

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Types of demand

• Derived demand• Joint demand • Composite demand (many use of a

commodity)• Direct demand (autonomous demand)

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Band wagon effect

17

In layman’s term the bandwagon effect refers to people

doing certain things because other people are doing

them, regardless of their own beliefs, which they may

ignore or override. The perceived "popularity" of an

object or person may have an effect on how it is viewed

on a whole. For instance, once a product becomes

popular, more people tend to "get on the bandwagon"

and buy it, too. 8/14/2013

Snob effect

In microeconomics, the snob effect is a phenomenon referring to the situation

where the demand for a certain good by individuals of a higher income level

is inversely related to the demand for the good by individuals of a lower

income level.

The "snob effect" contrasts most other microeconomic models, in that the

demand curve can have a positive slope, rather than the typical negatively

sloped demand curve of normal goods.

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Elasticity of demand

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Elasticity of demand

The degree of responsiveness of the demand for a good to a change in its price is called elasticity of demand.

qp

pq

pp

qqep ×

∆∆

=∆

÷∆

=

=pricein change percentage

demandedquantity in change percentage elasticity price

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Categories of Elasticity

– Relative elasticity of demand: EP > 1– Relative inelasticity of demand: 0 < EP < 1– Unitary elasticity of demand: EP = 1– Perfect elasticity: EP = ∞– Perfect inelasticity: EP = 0

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Determinants of elasticity of demand

• Price level (very costly & very cheap are elastic)• Substitutes are available (elastic) • Nature of the commodities

– Necessaries (inelastic)– Comforts(elastic)– Luxuries(elastic)

• Various uses (elastic)• Postponement (some time elastic)• Habit (inelastic)• Joint demand (both are same)

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Point method

ASAT

curvedemandtheofsgementuppercurvedemandtheofsgementlowered ==

islinestraight aon point aat demand of elasticity

A

T

SPRIC

QUANTITY

Lower segment

Upper segmentE

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Point Elasticity of Demand

• Elasticity differs along a linear demand curve.

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Total outlay method

25

• If price and total expenditure move in the same

direction= elasticity < 1

• If price and total expenditure move in the opposite

direction= elasticity > 1

• If total expenditure remains the same whether price

increases or decreases = elasticity = 1

E=1

E<1

E>1

Price

Total 8/14/2013

Income Elasticity

26

The percentage change in quantity demanded caused by a percent change in income.

• Y = IncomeYQEY ∆

∆=

%%

Consumer goods

Coefficient of income ed

Effect on sales with change in income

Essential E<1 Less than proportionate change in sale

Comfort E=1 Almost proportionate change in sale

Luxuries E>1 More than proportionate increase in sale8/14/2013

The Cross-Elasticity of Demand

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The percentage change in quantity consumed of one product as a result of a percent change in the price of a related product, i.e. complementary goods or substitutes goods.

B

AX P

QE∆∆

=%%

For a +ve cross-elasticity the products are substitutes productFor a –ve cross-elasticity the products are complimentary 8/14/2013

Arc Elasticity of DemandElasticity which is measured over a discrete

interval of a demand curve.

• Ep = Coefficient of arc price elasticity• Q1 = Original quantity demanded• Q2 = New quantity demanded• P1 = Original price• P2 = New price

2/)(2/)( 21

12

21

12

PPPP

QQQQEp +

−÷

+−

=

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Uses of elasticity in business decisions

• Price and cross elasticity's of demand are of greater significance in the pricing of a product aimed at maximizing the total revenue in the short run.

• Income elasticity of a product is of a greater significance in production planning and management in the long run particularly during the period of a business cycle.

• The income elasticity also used to define the normal and inferior goods. – +ve income elasticity is normal goods– -ve income elasticity is inferior goods

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Example

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Sol.

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units 400100,000-100,400shows estimate demand theso

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−=×−=×∂∂

=×∆∆

=

c

A

S

Y

P

Q

E

E

E

QP

PQ

QP

PQE

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Assignment - 31.The price of a commodity falls from Rs. 10

to Rs. 5 and its coefficient of price elasticity of demand is 2. how much quantity will be demanded to the changed price where original quantity demanded is 40.

2.A decline of Rs.2 in the price leads to an increase o f 10 units in the demand as a result of which demand goes up to 100 units and price declines to Rs.8. calculate price elasticity of demand.

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Assignment - 33. If the demand function is q=100-5p find

the elasticity of the demand at p=10.4. the demand law is given by x=10-p near

the point x=4, and p=6. if the price increases by 5%; determine the percent decrease in demand and hence an approximation to the elasticity of demand.

5. If the demand law is x=20/(p+1), find elasticity of demand with respect to price at the point where p=3.

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Assignment - 36. What is meant by elasticity of demand?

Explain what are different methods of measuring elasticity of demand. Suppose price elasticity co-efficient for a commodity is estimated at -2. what does it mean?

7. What do you mean by demand . Explain the difference between change in demand and change in quantity demand for a commodity.

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Thank you8/14/2013 35