BM- Demand

7/29/2019 BM- Demand

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Demand

Demand curve


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From indifference curves to demand

Decomposition of the reaction to a pricechange


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Substitution effect and income effect

Direction of these

Relative strengths of these


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Algebraic representation

Algebraically,

x/p = (x/p)comp

+ income effect

Income effect: -x x/I

This is negative when the good is normal and positive

when the good is inferior.The first , the substitution effect, is alwaysnegative.

Slutskys equation.


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Two implications of Slutskys eqn

1. For normal goods, the second term

becomes negativeWhy?The first term is always negative. Hence,

X /P is necessarily negative.

Therefore, normal goods necessarily obey

Law of Demand.

2. As -x becomes smaller income effect

becomes less and less significant. So can a

giffen good happen, even for inferior


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Results in differently sloped PCC curves

Demand derived from the PCC curves

And hence reflects the behaviour of PCC


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When PCC moves in the north easterly direction,

-What are the directions and relative strengths of the

two effects?

- what kind of a demand?

When PCC moves in the North westerly direction,- directions and strengths of the two effects?

- what kind of demand?


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Giffen goods

Stigler ,1966 noted that Anyone whosuccessfully isolated an exception to the

Law of Demand would be assured of

immortality( professionally speaking) and

rapid promotion. Since most economistswould not dislike either reward, we may

assume that the total absence of exceptions

is not from lack of trying to find them.


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Effect of income changes

Parallel shift of budget line

Relative prices remain constant

Income consumption curve


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ICC

For inferior goods

For normal ( superior) goods

Engel curves derived from ICC curves


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One application of Indifference curves

Comparison of cash and in-kind transfersRead the uploaded reading.


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Application of Indifference curves

Comparison of cash and in-kind transfers

Read the uploaded reading.

housing

food


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One more application

Buy one get one free.


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One more application

Buy one get one free.

Pizza

Other

goods

c

D E


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Demand curve

Demand as a function of its own price only

with all other factors affecting demand toremain constant.

Ceteris Paribus


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Demand curve

How to read off a demand curve?

Marginal valuation schedule

Consumers surplus


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Demand function

OTHER FACTORS AFFECTING DEMAND:

- Income

- Prices of related goods

- tastes and preferences

-others

* THESE ARE CAPTURED AS SHIFTS IN DEMAND


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Band wagon effect and snob effect

Positive network externalities

Negative network externalities.


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Market Demand

Conceptually- summation of individual

demands

How can this be operationalized??


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Market Demand

Resort to statistics, sample surveys.


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Moving forward with market

Demand

Question- instances from markets where

Price decrease has increased salesturnover?

Where price decrease has reduced

sales turnover?

Why? When P and Q are inversely related inboth cases?


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Market demand

Different slopes:

AB C


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Interpretation of slope

P1 Rs 10.00 per Kg Q 100 Kgs

P2 Rs 10.25 per Kg Q 90 KgsSlope?

P1 Rs 10.00 Q 100,000Gms P2 Rs 10.25 Q 90,000 gms

Slope?


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Market demand contd

SENSITIVITY OF DEMAND TO CHANGES IN PRICE

MEASURE OF THIS IS THE SLOPE MEASURE GIVEN BY:

Q/P

CONVENTION OF PLOTTING P ON THE Y-AXIS

*PROBLEM OF COMPARISON


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Market demand contd

A PROPORTIONATE UNIT-FREE MEASURE

ELASTICITY

It measures the propor t ionate change in Demand to a propor t ionate change in price


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Own Price elasticity of Demand

It measures the propor t ionate change in Demand toa propor t ionate change in price

Q/Q divided byP/PSimplified further asQ/P * P/Q

An example:

P Q

10 20012 192


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Price elasticity contd

Q/Q = -8/200 = -0.04

P/P = 2/10 = 0.2

Price elasticity = -0.04/0.2 = -0.2

Which Q and which P to take?

Take the average Q and the average P.

This is the Arc elasticity measure.


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*POINT ELASTICITY

At a Point- At a particular Q and at a particular P

Replace with d and we have:

dQ/dP * P/Q

How do we get dQ/dP?

We require the Demand Equation with Q as a function of P.


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Interpretation of Price Elasticity

Relationship between TR or TE and Price

elasticity


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Price elasticity and Total Revenue

If IPeI is < 1 , TR will increase with an

increase in price, and decrease with a

decrease in price

If IPeI is > 1, then TR will decrease with an

increase in price, and increase with a

decrease in price


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If (p0,q0) = (1,10)

And (p1,q1) = (2,4)What would be the elasticity if P0, q0 were

taken as the basis for arriving at proportions?


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Pe would be 3/5, 1 and the relationship between

Price change and Revenue change is maintained.

Hence the practice of taking averages for Arc

elasticities.


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Factors affecting Price Elasticity

- Number of Substitutes

- Necessities vs luxuries - Share of exp on the commodity in the

total budget

- time period Short run and long run


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Elasticity in the short and long run

Lower in the short run relative to the long

run?

or is it the other way?


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Does it depend on durability?

how would it be for automobiles, refrigerators,

Capital equipment?


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Durable vs non durable goods

Characteristics:

Discretionary spending?

inter temporal changes in demand- buyers adjust

their replacement times and this affects demand.

The total stock owned by consumers is large relative

to annual production?


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Hence the phenomenon in fig 2.12.


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Price elasticity

Short run price elasticity is likely to be ..

Long run price elasticity is likely to be.


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Price elasticity

Lower in the short run than in the long run for

non durables.

Higher in the short run than in the long run

for durables.


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P

Q

P

Q


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Other elasticities

INCOME ELASTICITY:

Q /I * I/Q Could be positive or negative.

Positive: Superior good

Negative: Inferior good

Short run Vs long run- Durable vs non

durable


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Cyclical industries

Demand for durables fluctuate sharply with

changes in income

Reflects changes in GDP.

Demand reflects GDP cycles, but magnified.


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Income elasticity

If low Demand is more stable duringfluctuations

In the long run, the share of consumerspending on inferior goods and normalnecessities tend to decline.

Therefore, what kind of businesses shouldone invest in to make profits in the long run?


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Volunteers to plot this?

%GDPgr

Annual

years

Airtraffic%change

Year on year

Could be automobiles


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Cross-Price elasticity

Qx / Py * Py/Qx

If Positive: Substitutes

If Negative: Complements


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Appln of Cross-price elasticity

Definition of industry or Product category

The case of Dupont

The case of Coke and Dr Pepper.

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BM- Demand