Upload
others
View
10
Download
0
Embed Size (px)
Citation preview
Managerial Economics
By
Dr. A.B. MukherjeePh.D., M.Phil., UGC NET, MBA, BBA
Module - 2
Theory of Demand and Demand Forecasting 8 Hours
• Meaning- determinants - demand schedule - demand curve.
• Law of Demand- exceptions- shifts in demand and
movements in demand.
• Elasticity of demand- meaning- types.
2
Determinants of Demand
A host of factors that determine the demand for a Product are:
1. Price of the Product.
2. Price of related goods – substitutes, complements and supplements.
3. Level of Consumer’s Income.
4. Consumer’s taste and preference.
5. Advertisement of the product.
6. Consumer’s expectation about future price and supply position.
7. Demonstration effect and ‘band-wagon effect’’.
8. Consumer-credit facility.
9. Population of the country (for the goods of mass consumption)
10. Distribution pattern of national income, etc.
3
Price of the Product
• The price of the product is one the most important determinants of its
demand in the long run and the only determinant in the short run.
• The price of a product and its quantity demanded are inversely related.
4
Price of Related Goods – Substitutes, Complements & Supplements
• The demand for a commodity is also affected by the changes in the price of
its related goods.
• Related goods may be substitutes and complementary goods.
Substitutes: Two commodities are deemed to be substitutes for one
another if change in the price of one affects the demand for the other in
the same direction.
For Example: Commodities X and Y are considered as substitutes for one
another if a rise in the price of X increases demand for Y and vice versa.
Tea and Coffee, hamburgers and hot-dog, alcohol and drugs are some
examples of substitutes in the case of consumer goods.
5
Price of Related Goods – Substitutes, Complements & Supplements
Complements: A commodity is deemed to be a complement for another
when its complements the use of the other or when the use of two goods go
together so that their demand changes simultaneously.
For Example: Petrol is complement to cars and scooters, butter and jam to
bread, milk and sugar to tea and coffee, mattress to cot, etc.
6
Level of Consumer’s Income
• Income is the basic determinant of quantity of a product demanded since
it determines the purchasing power of the consumer.
• Income-demand relationship is of a more varied nature than that between
demand and its other determinants.
• Income as a determinant of demand is equally important in both short run
and long run.
• For the purpose of Income- Demand analysis, consumer goods and
services may be grouped under four broad categories:
(a) Essential Consumer Goods (ECG)
(b) Inferior Goods (IG)
(c) Normal Goods (NG)
(d) Prestige or Luxury Goods (LG)
7
Essential Consumer Goods (ECG)
• The goods and services in this category are called ‘basic needs’ and are
consumed by all the persons in the society.
For Example: Food Grains, salt, vegetable oil, matches, cooking fuel,
minimum clothing and housing.
• Quantity demanded of this category of goods increases with increase in
consumer’s income but only upto a certain limit, even though the total
expenditure may increase in accordance with the quality of goods
consumed other factors remaining the same.
8
Inferior Goods (IG)
• Inferior goods and superior goods are widely known to both consumers
and sellers.
For Example: Millet is inferior to wheat and rice,, co Bidi is inferior to
cigarette, coarse textiles are inferior to refined ones, kerosene is inferior to
cooking gas, travelling by bus is inferior to travelling by aeroplane.
• In economic sense a commodity is deemed to be inferior if its demand
decreases with the increase in consumer’s income, beyond a certain level
of income.
Note:
• Demand for such goods rises only upto a certain level of income and
declines as income increases beyond this level.
9
Normal Goods (NG)
• Normal goods are those goods which are demanded in increasing
quantities as consumer’s income rises.
For Example: Clothing, household furniture and automobiles are some of
the important examples of this category of goods.
• Demand for normal goods increases rapidly with the increase in
consumer’s income but slows down with further increase in income.
10
Prestige or Luxury Goods (LG)
Luxury Goods:
• All such goods that add to the pleasure and prestige of the consumer without
enhancing his earning fall in the category of luxury goods.
For Example: Stone Studded Jewellery, Costly Brands of Cosmetics, Luxury
Cars, Accommodation in Five Star Hotel, Upper Class Air Travel can be treated
as luxury goods.
Prestige Goods:
• A special category of luxurious goods is that of prestige goods.
For Example: Precious Stones, Ostentatious decoration of buildings, rare
paintings and antiques, diamond studded jewellery and watches, prestigious
schools, etc.
Note: The demand for such goods arises beyond a certain level of
consumer’s income, i.e. Consumption enters the area of luxury goods.
11
Consumer’s Taste and Preference
• Taste and preference generally depend, on life style, social customs,
religious values attached to a commodity, habit of the people, the general
levels of living of the society and age and sex of the consumers.
• Change in these factors changes consumer’s taste and preferences.
• As a result, consumers give up the consumption of some goods and add
new ones in their consumption pattern.
12
Consumer’s expectation about Future price and Supply position
• Consumer’s expectation regarding the future prices, income and supply
position of goods, etc. play an important role in determining the demand
for goods and services in the short run.
• If consumers expect a high rise in the price of a storable commodity, they
would buy more of it at its high current price with a view of avoiding the
pinch of a high price rise in future.
• On the contrary, If consumers expect a fall in the price of certain goods,
they postpone their purchase of such goods with a view of taking
advantage of lower prices in future.
• Similarly an expected increase in income increases demand.
13
Demonstration Effect and ‘Band-Wagon Effect’
• Some people buy goods or new models of goods because they have a genuine
need for them or have excess buying power.
• Some others do so because they want to exhibit their affluence.
• Once the commodity is in vogue, many households buy then not because they
have a genuine need for them but because their neighbours have bought these
goods.
• Such purchases arise because of jealousy, competition and equality in the peer
group, social inferiority and the desire to raise their social status.
• Purchase on account of these factors is what economist call as
‘Demonstration Effect’ or ‘The Band Wagon Effect.’
14
Snob Effect
• On the contrary, when a commodity becomes the thing of common use,
some people, mostly rich, decrease or give up the consumption of such
goods.
• This is known as ‘Snob Effect’.
• It has a negative effect on the demand of the related goods.
15
Consumer Credit Facility
• Availability of credit to the consumers from the sellers, banks, relations
and friends, or from other sources encourage the consumers to buy more
than what they would buy in the absence of credit facility.
• Credit facility mostly affects the demand for durable goods, particularly
which require bulk payment at the time of purchase.
16
Population of the Country
• The total domestic demand for a product of mass consumption depends
also on the size of the population.
• Given the price, per capita income, taste and preference etc., the larger the
population, the larger the demand for a product.
17
Distribution Pattern of National Income
• The distribution pattern of national income is also an important
determinant of a product.
• If national income is unevenly distributed, i.e. If majority of the
population belongs to the lower income groups, market demand for
essential goods including inferior ones, will be the largest whereas the
demand for other kinds of goods will be relatively lower.
18
Exercise
Q1. Which one is example of Substitutes:
a) Tea & Sugar
b) Tea & Coffee
c) Pen & Ink
d) Shirt & Pant
19
Exercise
Q2. In case of Inferior goods, price effect is:
a) 0
b) Positive
c) Negative
d) None
20
Exercise
Q3. The fall in price of one commodity leads to fall in demand
for other commodity & vice-versa for:
(a) Substitutes
(b) Complimentary goods
(c) Giffen goods
(d) Veblen goods
21
Why the Demand Curve Slope Downwards?
1. Diminishing Marginal Utility
2. Substitution Effect
3. Income Effect
4. Change in Consumer’s Number
5. Different Uses
22
Diminishing Marginal Utility
• Law of Demand is based on Diminishing Marginal Utility concept.
• A consumer does not want to pay for a commodity more than its marginal
utility.
• As more and more units of a commodity are purchased the utility
acquired by these units decreases.
• Therefore with the decrease in prices, more and more quantity is
purchased.
23
Substitution Effect
• Another cause of downward slope of demand curve is Substitution Effect.
• When a need is fulfilled by two or more commodities it is called
Substitution Effect.
For Example: If the prices of kerosene comes down and the prices of coal
remains as it is, people would prefer kerosene for their purpose. As a
result the demand for kerosene increases as compared to its earlier
demand. In this way, due to substitution effect, demand for a commodity
is increased, while as price increases the demand for that commodity
increases.
24
Income Effect
• Due to decrease in prices there is increase in the real income of the
consumer or he can buy the same amount at less prices than he used to
purchase earlier.
For Example: Price of oil decreases from Rs. 15/- per litre to Rs. 10/- per
litre. So now if consumer maintains his consumption, he saves Rs. 5/- per litre
but if he wants to spend Rs. 5/- too, he can buy ½ litre resulting increase in the
demand of the commodity.
25
Change in Consumer’s Number
• When prices come down, those consumers who were not able to purchase
the commodity due to high prices, start consuming those product as a
result giving rise in the demand.
26
Different Uses
• Most of the commodities have different uses i.e. more than one use and
all the uses are not of the same importance.
• When prices come down consumers start using the product for less
important purpose also and when prices go up he becomes choosy about
the different uses that means that he uses the commodity on priority
basis.
27
Exercise
Q4. The quantity demanded of Pepsi has decreased. The best
explanation for this is that:
a) The price of Pepsi increased.
b) Pepsi consumers had an increase in income.
c) Pepsi's advertising is not as effective as in the past.
d) The price of Coca Cola has increased.
28
Exercise
Q5. Demand curves are derived while holding constant
a. Income, tastes, and the price of other goods.
b. Tastes and the price of other goods.
c. Income and tastes.
d. Income, tastes, and the price of the good.
29
Exercise
Q6. When the decrease in the price of one good causes the
demand for another good to decrease, the goods are:
a. Normal
b. Inferior
c. Substitutes
d. Complements
30
Exercise
Q7. Suppose the demand for good Z goes up when the price of
good Y goes down. We can say that goods Z and Y are:
a) Substitutes.
b) Complements.
c) Unrelated goods.
d) Perfect substitutes.
31
Elasticity of Demand
• The concept of Elasticity of Demand is associated with Alfred Marshall.
• Earlier we have seen that the Law of Demand was a Qualitative
Statement of Relationship between the Price of a Commodity and its
Quantity Demanded by the consumer.
• The Law of Demand did not specify any Quantitative Relationship
between the two.
For Example: A 10% fall in the prices of various goods shall not result in an
equal increase in their quantities demanded.
Suppose the prices of salt, oranges etc are cut down by 10% it does not mean
that the quantities demanded by consumer is increased by 10%.
If we take the example of salt only, 10% fall in price will result in only 2%
increase in demand.
32
Elasticity of Demand
• “Elasticity of Demand may be defined as the extent to which the quantity
demanded of a commodity changes in response to a given change in price.”
• In case of Elastic Demand the quantity demanded of a commodity is
highly sensitive or responsive to even a small change in price.
• But in case of Inelastic Demand even a drastic change in price may not
affect the quantity demanded.
• In the words of Marshall – “Elasticity of demand in a market is great or
small according as the amount demanded increases much or little for a
given fall in the price and diminishes much or little for a given rise in
price”.
33
Elasticity of Demand
34
Types of Elasticity of Demand
Price Elasticity of Demand
Income Elasticity of Demand
Cross Elasticity of Demand
Substitution Elasticity of Demand
Perfectly Elastic
Perfectly Inelastic
Relative Elastic
Relative Inelastic
Unitary Elastic Demand
Zero Income Elasticity of Demand
Negative Elasticity of
Demand
Unitary Income Elasticity of Demand
Income Elasticity of Demand Greater than
Unity
Income Elasticity of Demand Less than Unity
Infinite Substitution Elasticity
Zero Substitution Elasticity
High or Low Substitution Elasticity
Types of Elasticity of Demand
• Price Elasticity of Demand
• Income Elasticity of Demand
• Cross Elasticity of Demand
• Substitution Elasticity of Demand
35
PRICE ELASTICITY OF DEMAND
36
Price Elasticity of Demand
• It is one of a family of concepts of elasticity.
• Alfred Marshall was the first economist to give a clear formulation of price
elasticity.
• It is the ratio of proportionate changes in the quantity demanded of a
quantity demanded of a commodity to a given proportionate change in
price.
• If Price Elasticity of Demand is Ep then :
Ep = Relative change in Quantity /Relative Change in Price
• In other words elasticity is the percentage change in quantity to the
percentage change in price
37
Types of Price Elasticity of Demand
• Perfectly Elastic Demand
• Perfectly Inelastic Demand
• Relative Elastic Demand
• Relative Inelastic Demand
• Unitary Elastic Demand
38
Perfectly Elastic Demand
39
Perfectly Elastic Demand
• The situation where the slightest rise in the price causes the quantity
demanded to fall to zero and the slightest fall in price causes an infinite
increase in quantity demanded of the commodity is called Perfectly
Elastic Demand situation.
• The demand in such cases is hyper sensitive and elasticity of demand is
infinite.
• In actual life Perfectly Elastic Demand is very rare phenomenon.
40
Perfectly Inelastic Demand
41
Perfectly Inelastic Demand
• It refers to a situation where even substantial change in price leaves the
demand unaffected.
• In other words the price may change but the quantity demanded remains
unchanged.
• The demand in such case is insensitive or non responsive and the elasticity
of demand is zero.
• Like Perfectly Elastic Demand cases of Perfectly Inelastic demand are also
rare in real life.
42
Relative Elastic Demand
43
Relative Elastic Demand
• It refers to that situation where a small proportionate change in the price of
any commodity results in a large proportionate change in its quantity
change.
• In other words – ‘A small proportionate fall in price is followed by a large
proportionate increase in demand and vice-versa.’
44
Relative Inelastic Demand
45
Relative Inelastic Demand
• It refers to that situation where a big proportionate change in the price of a
commodity is accompanied by a smaller proportionate change in its
quantity demanded.
• Elasticity of Demand here is said to be less than unity.
46
Unitary Elastic Demand
47
Unitary Elasticity of Demand
• It refers to that situation where a given proportionate change in price is
accompanied by an equal proportionate change in the quantity demanded.
• Elasticity of demand equal to unity.
48
Review of Price Elasticities of Demand
1. Perfectly Elastic (Ep = ∞)
2. Perfectly Inelastic (Ep = 0)
3. Relative Elastic (Ep > 1)
4. Relative Inelastic (Ep < 1)
5. Unitary Elastic Demand (Ep = 1)
49
EXERCISE
Q1. The price elasticity of demand measures
A) the slope of a budget curve.
B) how often the price of a good changes.
C) the responsiveness of the quantity demanded to changes in
price.
D) how sensitive the quantity demanded is to changes in
demand.
50
EXERCISE
Q2. The Price Elasticity of Demand depends on:
A) the units used to measure price but not the units used to measure
quantity.
B) the units used to measure price and the units used to measure quantity.
C) the units used to measure quantity but not the units used to measure
price.
D) neither the units used to measure price nor the units used to measure
quantity.
51
EXERCISE
Q3. The price elasticity of demand equals:
A) the percentage change in the quantity demanded divided by the
percentage change in the price.
B) the change in the quantity demanded divided by the change in price.
C) the percentage change in the price divided by the percentage change in
the quantity demanded.
D) the change in the price divided by the change in quantity demanded.
52
EXERCISE
Q4. The price elasticity of demand can range between:
A) negative one and one.
B) zero and infinity.
C) zero and one.
D) negative infinity and infinity
53
EXERCISE
Q5. Demand is inelastic if :
A) a large change in quantity demanded results in a small change in price.
B) the price elasticity of demand is greater than 1.
C) the quantity demanded is very responsive to changes in price.
D) the price elasticity of demand is less than 1.
54
EXERCISE
Q6. Of the following, demand is likely to be the least elastic for
A) Toyota automobiles.
B) compact disc players.
C) Ford automobiles.
D) toothpicks.
55
INCOME ELASTICITY OF DEMAND
56
Income Elasticity of Demand
• Income Elasticity of Demand for a commodity shows the
extent to which a consumer demands for that commodity as a
result of a change in his income.
• It shows the responsiveness of a consumer purchases of that
commodity to a change in his income.
• Income Elasticity of demand may be defined as the ratio of
proportionate change in the quantity of the commodity to a
given proportionate change in the income of consumer.
57
Types of Income Elasticity of Demand
1. Zero Income Elasticity of Demand.
2. Negative Elasticity of Demand.
3. Unitary Income Elasticity of Demand.
4. Income Elasticity of Demand greater than unity.
5. Income Elasticity of Demand less than unity.
58
1. Zero Income Elasticity of Demand
• This situation refers to the situation where a given increase in
the consumer’s money income does not result in any increase
of the quantity demanded of the commodity.
• Thus in Zero Income Elasticity of Demand EI = 0
59
2. Negative Elasticity of Demand
• That refers to the situation where a given increase in the
consumer’s money income is followed by an actual fall in the
quantity demanded of the commodity.
• This happens in the case of inferior goods.
• Thus in Negative Elasticity of Demand EI < 0
60
3. Unitary Income Elasticity of Demand
• This refers to the situation where the proportionate change in
the consumer’s income spend on the commodity is actually
the same both before and after the increase in income.
• The Income Elasticity of Demand is Unity.
• In such case EI = 1
61
4. Income Elasticity of Demand greater than Unity
62
• This refers to the situation where the consumer spends a
greater proportion of his money income on the commodity
when he becomes richer and more prosperous.
• The Income Elasticity of Demand is greater than unity in case
of Luxuries.
• Thus Income Elasticity of Demand Greater than Unity is
represented as EI > 1
5. Income Elasticity of Demand less than Unity
63
• This refers to the situation where the consumer spends a
smaller proportion of his money income when he becomes
richer and more prosperous.
• The Income Elasticity of Demand is less than Unity in the case
of necessaries.
• The expenditure increases in a smaller proportion when the
consumer’s money income goes up.
• Thus Income Elasticity of Demand Less than Unity is
represented as EI < 1.
Factors Affecting Elasticity of Demand
1. Degree of Necessity.
2. Proportion of Consumer’s Income spent on the commodity.
3. Existence of Substitutes.
4. Habit.
5. Several uses of the commodity.
6. Postponement.
7. Time.
8. Range of Price.
64
CROSS ELASTICITY OF DEMAND
65
Cross Elasticity of Demand
• Normally the commodities are seldom completely independent.
• They are surrounded by substitutes and complements.
• The two goods say X and Y can either be substitutes of each other or
complementary to each other.
• In the case of substitute goods and complementary goods the term
Cross Elasticity of Demand may be defined as the ratio of
proportionate change in the quantity demanded of commodity X to a
given proportionate change in the price of the related commodity Y.
• EC = % age change in the quantity demanded of X
% age change in the price of Y
66
SUBSTITUTION ELASTICITY OF DEMAND
67
Substitution Elasticity of Demand
• Substitution Elasticity may be defined as the extent to which
one commodity can be substituted for another as a
consequence of a given change in their price ratio.
• If the consumer continues to enjoy the same amount of
satisfaction the ratio in which the two commodities are
bought naturally changes when the process of substitution
takes place.
68
Example of Substitution Elasticity
Commodities Price per Kg Consumer
Purchase
Qty Ratio Price Ratio
Margarine Rs. 5/- per Kg 3 Kgs3:2 1:2Butter Rs. 10/- per Kg 2 Kgs
69
Commodities Price per Kg Consumer
Purchase
Qty Ratio Price Ratio
Margarine Rs. 5/- per Kg 5Kgs5:1 1:3Butter Rs. 15/- per Kg 1Kg
Example of Substitution Elasticity
• The original Margarine and Butter ratio was 3:2 while the new ratio is
5:1.
• The proportionate change in the margarine butter ratio is
3/2 – 5/1 = - 7/2 / 3/2 = -7/3
• The original price ratio was ½ while the new price ratio is 1/3.
• The proportionate change in price ratio is (1:2 – 1:3) / 1:2 = 1:3
• Elasticity of Substitution
Es = Proportionate change in the combination ratio of goods X and Y
Proportionate change in the price ratio of goods X and Y.
• In the above Example Es will be -7/3 /1/3 = -7 or = + 7
70
Infinite Substitution Elasticity
• The Substitution Elasticity will be infinite if two commodities are perfect
substitutes of each other.
• A fall in price of one commodity assuming the price of the other to be
constant will lead the consumer to substitute the former completely for the
latter.
• The Elasticity of Substitution then will be infinite but in actual life we
rarely come across two commodities which are perfect substitutes of each
other.
71
Zero Substitution Elasticity
• The Elasticity of Substitution will be zero if two commodities are no
substitutes for each other.
• In such a case the rate of substitution between them will be zero or we can
say that their will be no possibility of substitution between the two
commodities.
• Even if the price ratio of two commodities changes the consumer will not
be able to substitute one commodity for the other.
• Hence Elasticity of Substitution will be Zero.
72
High or Low Substitution Elasticity
• Between the other two extremes limits of infinite and zero elasticities, we
can have high or low substitution elasticities depending on whether the
rate of substitution between the two commodities falls gradually or rapidly.
• If the rate of substitution falls gradually the elasticity of substitution will
be high.
• On the contrary, if the rate of substitution falls rapidly the Elasticity of
Substitution will be low.
73
Points to Remember
Elasticity, Price-Change and Change in TR
74
Elasticity Coefficient Change in Price Change in TR
e = 0 IncreaseDecrease
IncreaseDecrease
e < 1 Increase Decrease
IncreaseDecrease
e = 1 Increase Decrease
No Change No Change
e > 1 IncreaseDecrease
DecreaseIncrease
e = OO IncreaseDecrease
Decrease to ZeroInfinite increase*
Points to Remember
Income Elasticities
75
Consumer Goods Elasticity Coefficient Change in TR
1. Essential Goods Less than one (ey < 1) Less thanproportionate change
in sale
2. Comforts Almost equal to unity (ey = 1)
Almost proportionate change in sale
3. Luxuries Greater than unity(e > 1)
More than proportionate increase
in sale
EXERCISE
Q7. If a price decrease results in your expenditure on a good
decreasing, your demand must be:
A) unit.
B) inelastic.
C) linear.
D) elastic.
76
EXERCISE
Q8. If the demand for a good is unit elastic,
A) A 5 percent increase in price results in a 5 percent increase in
total revenue.
B) the demand curve is a straight line with slope of -1.
C) a 5 percent increase in price results in a 5 percent decrease in
total revenue.
D) a 5 percent increase in price does not change total revenue.
77
EXERCISE
Q9. Suppose that the quantity of root beer demanded declines
from 103,000 gallons per week to 97,000 gallons per week as a
consequence of a 10 percent increase in the price of root beer.
The price elasticity of demand is:
A) 1.66
B) 6.00
C) 0.60
D) 1.40.
78
EXERCISE
Q10. When the quantity of coal supplied is measured in
kilograms instead of pounds, the demand for coal becomes:
A) more elastic.
B) neither more nor less elastic.
C) less elastic.
D) undefined.
79
THANK YOU
HAVE A GREAT DAY AHEAD!!!
80