Demand

							        Chapter 3

Demand and Its Application
           What is demand
 Demand   refers to the quantities of a
 good that purchasers are willing and
 able to buy at various prices per period
 of time, other things remaining
 constant
          Elements of demand
 Willingness

 Ability

 Price

 Quantity

 Time

 Other   things being equal
Demand Schedule for Broccoli
Law of demand - A Downward Sloping Demand
  Curve. higher the price, lower the demand
        Determinants of demand
   Price
   Price of related good (Substitute &
    Complementary)
   Income
   Tastes and preferences
   Other factors (fashion, future expectation,
    population, weather, distribution of income,
    state of business etc)
             Demand function
   Dx = f (Px ;Py; Y; T………)

 Dx = Demand for X commodity
 f = function of ( or depends upon)
 Px = Price of X commodity
 Pr = Price of related commodity
 Y = Consumer’s income
 T = Taste of consumer
Why demand curve slopes downwards
         Market Demand Curve
 Market or aggregate         Px Qd1 Qd2 Qd3 Mar
  demand for a                               ket
  commodity gives
  alternative amounts of      6   9    18   30   57
  commodity demanded
  by all individuals in the
  market                      5   10   20   32   62
 Exceptions:
Bandwagon effect
                              4   12   24   36   72
Snob effect
Increase/decrease in demand vz
     extension/contraction
    Exceptions to law of demand
 Inferior goods
 Veblen goods – rare goods
 Necessities of life
 Future expectation regarding price rise
 Abnormal conditions as floods, famine etc
 Hobbies
 Addictions
                Supply
 Supply refers to the quantities of a
 product that suppliers are willing and
 able to sell at various prices per unit of
 time, other things remaining the same
Supply of Broccoli
Law of Supply - Upward sloping Supply Curve of
                  Broccoli
         Factors affecting supply
   Quantity
   Product – perishable vz non perishable
   Suppliers
   Technology
   Time period
   Storage facilities
   Cost of production
Equilibrium in the Broccoli Market
      How equilibrium price is set
Price Q          Q         Surplus/   Pressure on
      Demand     Supply    shortage   price
1.2    100,000   400,000   +300,000   downward
1.1    125,000   350,000   +175,000   downward
1.0    150,000   300,000   +150,000   downward
.9     175,000   250,000   +75,000    downward
.8     200,000   200,000   0          equilibrium
.7     225,000   150,000   -75,000    upward
.6     250,000   100,000   -150,000   upward
.5     275,000   50,000    -225,000   upward
Market Adjustment to Equilibrium
     Demand, supply and shifts in
           equilibrium
 Demand Shift
 Supply Shift

 Effect on equilibrium

E.g. Changes in demand and supply and price of
  PCs
                   Elasticity
“The price elasticity of demand is a measure of how
  much the quantity demanded of a good responds
  to a change in the price of that good”

  Determinants:
     Availability of close substitutes
     Necessities vs luxuries
     Definition of the market
     Time horizon
     Proportion of Income spent
    What is income and cross elasticity
   “The income elasticity of demand (e i) = is a measure of
    how much the quantity demanded of a good responds to a
    change in consumers’ income, computed as the percentage
    change in quantity demanded divided by the percentage
    change in income.”

   “The cross-price elasticity of demand ( e xy) = is a measure
    of how much the quantity demanded of one good responds
    to a change in the price of another good, computed as the
    percentage change in quantity demanded of the first good
    divided by the percentage change in the price of the second
    good.”
          Measures of Elasticity
   A. Point Elasticity = (Q2-Q1) / Q1* 100
               (P2-P1) / P1 * 100

B. Arc Elasticity =
                  (Q2-Q1)/[(Q2+Q1)/2] * 100
                  (P2-P1)/[(P2+P1)/2] * 100
PRICE   QUANTITY DEMANDED

$40           250
$30           450
$20           675
$10           825
Price


   P1
                Inelastic Demand
                Elasticity less than 1

   P2




                D

        Q1 Q2              Quantity
          D
Price



   P1
                  Perfectly Inelastic Demand
                  Elasticity equals 0

   P2




        Q1 = Q2    Quantity
Price



             Elastic Demand
             Elasticity greater than 1

   P1
   P2
                                         D




        Q1      Q2      Quantity
Price



               Perfectly Elastic Demand
               Elasticity equals infinity



P1 = P2
                                     D




          Q1      Q2     Quantity
Impact of a Price Increase on
        Expenditure
   Inelastic        Rises


    Elastic         Falls


  Unit elastic     Constant
PRICE QUANTITY ELASTICITY EXPENDITURE CHANGE IN
               OF DEMAND             EXPENDITURE

40     250                 10,000
                 2.0                   -3,500
30     450                 13,500
                 1.0                     0
20     675                 13,500
                  .3                   5,250
10     825                 8,250
Summary of Relationship Between Price Elasticity of Demand and
                        Total Revenue
    Relation of price elasticity and MR
   MR = P ( 1 + 1/Ep)
                                     (Figure continues on next slide)

Relationships Among Total Revenue; Marginal Revenue; Average
            Revenue; and Price Elasticity of Demand
                      +/- +/-   +/-
           QdX = f(PX, I, PY, T )


QdX/PX < 0+
QdX/I > 0 if a good is normal
QdX/I < 0 if a good is inferior
QdX/PY > 0 if X and Y are substitutes
QdX/PY < 0 if X and Y are complements
        Applications of Elasticity
   Air fares pricing
   Agricultural products
   Demand for gasoline in long run
   Taxes on Cigarettes
   Engel’s law
   Maximising revenue
   Price discrimination in different markets