Economic Analysis

Lecture 02
Demand Analysis

Dr. Preeti Bajaj

If you cant pay for a thing, dont buy

it.
If you cant get paid for it, dont sell
it.
Benjamin
Franklin

Demand
Human wants are unlimited
Can I fulfill all my wants?
Demand is defined as that want, need
or desire which is backed by willingness
and ability to buy a particular
commodity in a given period of time.
Demand is the quantity of commodity
which consumers are willing to buy at a
given price for particular unit of time.

Types of demand
Categories are based on:
Nature of commodity demanded
(consumer goods and capital goods)
Time unit for which it is demanded
(short-run and long-run)
Relation between two goods(composite/unrelated)

Direct or Derived
Direct commodity demanded for its own
sake, i.e. by final consumer
Called consumer goods
E.g. TV, cell phones, computer, furniture

Derived commodity if demanded for

using it either as a raw material or as an
intermediary for value addition
Called capital goods
E.g. demand for buildings increase => demand
for construction material also increases

Recurring and Replacement demand

Consumer goods => consumables and
durables
Consumable goods have recurring demand, i.e.
they are consumed at frequent intervals e.g.
eat snacks 3 or 4 times a day, read newspaper
everyday, fill petrol once a week
Goods like TV, car, bikes are examples of
durable consumer goods used for a long
period of time they suffer wear and tear over
time or obsolescence of technology they need
replacement

Complementary and
Competing
Complementary goods jointly demanded demand for one commodity is dependent on
demand for another.
E.g. car and petrol, computer and software

When more than one good is demanded to

satisfy a want, they are called complementary
goods
Competing goods goods which independently
satisfy any particular want called substitutes
E.g. coke and Pepsi, investing in government bonds or
company deposits, etc.

Individual or Market
demand
Demand of an individual consumer
Demand for the product of all firms in
an industry market / industry
demand
E.g. Xs demand for Maruti Swift is
individual demand
Total sale of Swift in the year, say 2009,
is the annual market demand

DETERMINANTS OF
DEMAND

Factors Affecting Demand

Price of the good
Taste or level of desire for the product by the buyer
Income of the buyer
Prices of related products:
substitute products (directly competes with the good in the opinion of
the buyer)
complementary products (used with the good in the opinion of the
buyer)
Future expectations:
expected income of the buyer
expected price of the good.
For the total market demand (rather than Bob's individual one) the
number of buyers in the market is also a determinant of the amount
purchased.

Law of Demand
Law of Demand states
that ceteris paribus,
demand for a product is
inversely proportional to
its price.
Other things remaining
constant, when price of a
commodity rises, the
demand for that
commodity falls, and vice
versa.
D = f(Px)

Web-link
http://www.dineshbakshi.com/ib-eco
nomics/microeconomics/161-revision
-notes/1695-what-is-demand
https://www.khanacademy.org/econom
ics-finance-domain/microeconomics/
supply-demand-equilibrium/demand-c
urve-tutorial/v/law-of-demand

Class game
http://www.econom
icsnetwork.ac.uk/s
howcase/guest_exp
eriments

http://www.econom
icsnetwork.ac.uk/th
emes/games/tennis
%20balls

Reasons behind Law of

Demand
Price effect
1.goods have multiple uses a fall in prices induces a
consumer to put it to alternative uses, i.e. they are
demanded in larger quantities.

2. fall in price induces those consumers to buy who

could not afford it earlier.
Substitution effect when price falls, it is
substituted for more expensive goods.
Income effect when price falls, real income of
the consumer increases, money income remaining
the same purchasing power increases buys
more.

Basis for the Law of Demand

The foundation for law of demand is law of diminishing marginal utility.
Marshall derived law of demand from law of diminishing marginal utility. Law
of diminishing marginal utility states that utility derived from additional units
of a commodity keeps declining.
For example, when you eat the first slice of pizza, you get more satisfaction
from it. Here satisfaction means utility. At the same time, when you start
eating more pizza slices, the utility you derive from every additional unit
becomes less and less. This occurs because you reach the saturation level.
From this diminishing marginal utility concept, you can derive law of demand.
Let us consider the same Pizza example. Since the first pizza gives more
utility, you do not bother about the price of it. Hence, you tend to buy an
pizza even at a high price. However, additional units of pizza give you less
and less utility. Hence, you do not want to buy additional slices of pizzas at a
high price anymore. Now the seller has to lower the price of pizzas to increase
the demand. When the price is declined, you start buying more pizzas again.
In this manner, law of diminishing marginal utility paves a path to law of
demand.

Movement along the curve

Movement along the
same demand curve is
expansion /
contraction of demand
due to fall / rise in price.
In other words, a
movement occurs when
a change in quantity
demanded is caused
only by a change in
price, and vice versa.

Shift in demand curve

Imagine price of coffee
remaining the same, the
demand increases whats
the reason?
A variable other than price
has changed e.g. income of
consumers
Can you show it on the
demand curve?
A new demand curve has to
be drawn.
Shift of demand curve due to
change in factors other than
price is called a change in
demand

Exception to law of demand

Giffen Goods

Veblen effect

Speculations

Exceptions
Inferior goods - An inferior good is one the consumption of
which falls as incomes rise: it has a negative income
elasticity of demand. This contrasts with a normal good, the
consumption of which increases as incomes rise.
A rare and extreme type of inferior good, a Giffen good, is
subject to such a strong income effect that consumption
increases with higher prices.
Giffen goods goods display a direct relationship with price.
The existence of such goods was postulated by the
economist Robert Giffen , who observed that, under some
circumstances, the poor consume more bread as its price
rises.

 Such change reflects two interacting effects of a price rise.

First, as the price of a good rises, the consumer's purchasing
power declines; for inferior goods, this income effect is
positivethe consumer will tend to consume more of the
good because superior alternatives are less affordable.
Second, when the price rises relative to other goods, the
substitution effect shifts demand toward relatively cheaper
alternatives.
These two forces act in opposite directions, making the
change in demand theoretically ambiguous. In most
circumstances, the substitution effect would be expected to
predominate, so that a price increase results in a reduction in
quantity purchased. But in circumstances where one inferior
good makes up a very large share of the budget (e.g., bread
for the poor), consumption of the good may increase due to a
price increase.

Veblen
goods
Veblen goods goods have snob value consumer
measures the satisfaction derived not by their utility value
but by social status e.g. diamonds, works of art.
The Veblen effect is named after the economist Thorstein
Veblen, who first pointed out the concepts of conspicuous
consumption and status-seeking
Some types of high-status goods, such as high-end wines,
designer handbags and luxury cars, are Veblen goods, in
that decreasing their prices decreases people's preference
for buying them because they are no longer perceived as
exclusive or high status products.
Similarly, a price increase may increase that high status
and perception of exclusivity, thereby making the good
even more preferable.

Elasticity
The degree to which a demand or supply curve reacts to a
change in price is the curve's elasticity.
Elasticity = (% change in quantity / % change in price)
If elasticity is greater than or equal to one, the curve is
considered to be elastic. If it is less than one, the curve is said to
be inelastic.
Elasticity varies among products because some products may be
more essential to the consumer.
Products that are necessities are more insensitive to price
changes because consumers would continue buying these
products despite price increases.
Conversely, a price increase of a good or service that is
considered less of a necessity will deter more consumers because
the opportunity cost of buying the product will become too high.

Web Link
https://www.mackinac.org/1247

Elastic goods
A good or service is considered to
be highly elastic if a slight change
in price leads to a sharp change in
the quantity demanded or supplied.
Usually these kinds of products are
readily available in the market and
a person may not necessarily need
them in his or her daily life.
On the other hand, an inelastic
good or service is one in which
changes in price witness only
modest changes in the quantity
demanded or supplied, if any at all.
These goods tend to be things that
are more of a necessity to the
consumer in his or her daily life.

Inelastic goods
Inelastic demand is
represented with a
much more upright
curve as quantity
changes little with
a large movement
in price.

Factors Affecting Demand

Elasticity
The availability of substitutes Amount of income available to spend
on the good Time Period
Necessity Vs. luxury
Habit forming Goods
No. of Uses of the product

Web Feed
http://www.investopedia.com/video/pl
ay/price-elasticity-demand/
https://www.inkling.com/read/managerial-economics/chapter3/table-3-1

Income elasticity of demand

The degree to which an increase in
income will cause an increase in
demand is called income elasticity of
demand, which can be expressed in
the following equation:
Income Elasticity = (% change in
quantity / % change in income)

Cross-price elasticity of
demand
Cross-price elasticity of demand measures
how the quantity demanded of one good
changes as the price of another good
changes.
Cross-Price Elasticity = (% change in
quantity demanded of good x / %
change in price of good y)
Cross elasticity is positive or negative
depends on whether the two goods are
substitutes or complements

Theadvertising elasticity of
demand
Measures the responsiveness of a
goods demand to changes in
spending on advertising. The
advertising elasticity of demand
measures the percentage change in
demand that occurs given a 1
percent change in advertising
expenditure.

Formula

The symbol Arepresents the advertising elasticity of demand.

In the formula, the symbol Q0represents the initial demand or
quantity purchased that exists when spending on advertising
equals A0. The symbol Q1represents the new demand that
exists when advertising expenditures change to A 1.

Some Take Aways

The advertising elasticity of demand should be positive. (A
negative value would indicate the more you spend on
advertising, the lower your sales. That is a really bad ad! You
should probably fire whomever is in charge of advertising.)
As with all elasticity values, the larger the number, the more
responsive the goods demand is to a change in advertising.
Your vending machine company starts a new ad campaign,
Vend for Yourself. Currently, your company sells soft drinks
at $1.50 per bottle, and at that price, customers purchase
2,000 bottles per week. Initially, you spend $400 per week
on advertising. After a month, youre spending $500 per
week on advertising and, without changing the price of soft
drinks, sales have increased to 3,000 bottles per week.

To determine the advertising elasticity of

demand, follow the customary steps:
Because $400 and 2,000 are the initial advertising expenditures and
quantity sold, put $400 into A0and 2,000 into Q0.
Because $500 and 3,000 are the new spending on advertising and sales,
put $500 into A1and 3,000 into Q1.
Divide the expression on top of the equation.
(Q1 Q0) equals 1,000 and (Q1+ Q0) equals 5,000. Dividing 1,000 by 5,000 equals
1/5.
Divide the expression in the bottom of the equation.
(A1 A0) equals $100, and (A1+ A0) equals $900. Dividing $100 by $900 equals 1/9.
Divide the top result, 1/5, by the bottom result, 1/9.