Demand

Desire + ability to pay + willingness to pay

Price Income Prices of related goods Taste and preferences Customs and traditions Government policy Advertising Population Location Service Quality

A decrease in the price of a good, all other things held constant, will cause an increase in the quantity demanded of the good and an increase in the price of a good will cause a decrease in the quantity demanded of the good.

Price

P1 P0

An increase in price causes a decrease in quantity demanded.

Q1

Q0

Quantity

Price

A decrease in price causes an increase in quantity demanded.

P0 P1 Q0 Q1 Quantity

Price

An increase in demand refers to a rightward shift in the market demand curve.

P0

Q0

Q1

Quantity

Price

A decrease in demand refers to a leftward shift in the market demand curve.

P0

Q1

Q0

Quantity

Law of diminishing marginal utility Income effect Substitution effect Multiplicity of uses

Giffen Goods Prestigious goods Buyers illusions Necessary goods Brand loyalty Monopoly Speculation

Elasticity is a measure of responsiveness of one variable to another variable. Can involve any two variables. An elastic relationship is responsive. An inelastic relationship is unresponsive.

Price Elasticity of demand Income elasticity of demand Cross Elasticity of demand Promotional Elasticity of demand

 )p=%(Q/%(P

An elastic response is one where numerator is greater than denominator. i.e., %(Q>%(P so Ep " An inelastic response is one where numerator is smaller than denominator. i.e., %(Q<%(P so Ep 

Perfectly Elastic D Ep !infinite

Perfectly Inelastic D

Ep !0
D

D is relatively more elastic than D P1 P2 D Q1 Q2 Q2 D Q

Price (Rs.)

Point elasticity  Point elasticity is responsiveness at a point along the demand function D

Ep !(Q/Q1 (P/P1 simplifying: Ep !(Q/(P)* P1 /Q1

Price (Rs.)

Point elasticity  Point elasticity is responsiveness at a point along the demand function D

Ep !(Q/Q1 (P/P1 simplifying: Ep !(Q/(P)* P1 /Q1

Point elasticity

Price (Rs)

Ep !(Q/(P)* P1 /Q1

Suppose P=17000 Q=56-0.002*17000 Q=56-34=22 Plug into equation gives: Ep !-0.002)* 17000 /22 Ep =-34/22=-1.54

7k D

Arc elasticity is simply an average elasticity along a range of the demand curve.

 The end-point problem

the percentage change differs depending on whether you view the change as a rise or a decline in price.

Arc elasticity: Price ($) Responsiveness along a range of D. function Avg. responsiveness
1

Ep !(Q/((Q1+Q2)/2) (P/((P1+ P2)/2) simplifying:

Ep!(Q/(P)*((P1+P2)/(Q1+Q2))

Q Q1

Arc elasticity

Price ($)

Ep !(Q/(P)*((P1+P2)/(Q1+Q2)) Look at P range 16k - 17k Q=56-0.002*17000 Q=56-34=22 Plug into equation gives:
Ep !-0.002)*(33000/46) Ep =-66/46=-1.43

7k 16 D 22 24

Nature of commodity Availability of substitute Multiplicity of uses Habit Proportion of income spent Price range

Pricing Decision Taxation Labor market International trade

EI = % ( Qd / % ( Id
Measures the sensitivity of DEMAND to changes in disposable income.

Shows the relationship between quantity demanded and disposable income given a constant price.

Disposable Income

Engel Curve for a Normal Good EI > 0

Qd/ut

Luxury Goods are Normal Goods but they have an

Quantity demanded is very senstive to changes in disposable income

EI >= 1

Necessities are Normal Goods but

0 < EI < 1
Quantity demand is not very sensitive to changes in disposable income

Disposable Income

Engel Curve for an Inferior Good EI < 0

Qd/ut

 Normal Goods (EI >0)

 Luxury Goods (EI >= 1)  Necessitites (0 < EI < 1)

Inferior Goods (EI < 0)

Measures how sensitive DEMAND for a commodity is to changes in the price of a substitute or compliment commodity

Ecp of x,y =

% ( Qx / % ( Py

Ecp > 0 Substitute Ecp < 0 Compliment Ecp = 0 Independent

Rate of change in demand for a commodity due to a change in promotion expenditure

For many crops, a strange situation arises a bad crop year results in a good year for farm incomes, and a good crop year results in a bad year for farm incomes. How can this happen to farm community?

Price elasticity gives us the answer:

 Bad crop year: supply decreases, prices for farm products

rise, but quantity demanded doesn t fall very much. The quantity demanded of farm products is not very responsive to changes in prices  Good crop year: supply increases, prices for farm products fall, but quantity demanded doesn t increase very much. The quantity demanded of farm products is not very responsive to changes in prices

It is easy to show this with a graph. But first we need yet another concept: Total Revenue = Price x Quantity

TR = P x Q If P goes down Q goes up, but what happens to TR? If P goes up Q goes down, but what happens to TR? Elasticity can answer the question .

During bad crop years, prices rise and quantity falls (but not that much) so total revenue to farmers goes up. During good crop years, prices fall and quantity increases (but not that much) so total revenue to farmers goes down. The graphs .

An Increase in Supply in the Market for Wheat

Price of Wheat 2. . . . leads to a large fall in price . . . $3 2

1. When demand is inelastic, an increase in supply . . . S1 S2

Demand 0 100 110 Quantity of Wheat

3. . . . and a proportionately smaller increase in quantity sold. As a result, revenue falls from $300 to $220.
Copyright2003 Southwestern/Thomson Learning

It is an objective assessment or estimation of future course of demand - Micro level - Industry level - Macro level

Production planning Evolving sales policy Fixing sales targets Determining price policy Inventory control Determining short-term financial planning

Business planning Manpower planning Long-term financial planning

Consumers interview Sales force polling Experts opinion Delphi End- use Market Experimentation Trend projection Causal regression

Price Input Price Technology Government regulations and taxes Number of firms Substitutes in production Producer expectations

An equation representing the supply curve: QxS = f(Px , PR ,W, H,)

 QxS = quantity supplied of good X.  Px = price of good X.  PR = price of a related good  W = price of inputs (e.g., wages)  H = other variable affecting supply

A decrease in the price of a good, all other things held constant, will cause a decrease in the quantity supplied of the good and an increase in the price of a good will cause an increase in the quantity supplied of the good.

Price

A decrease in price causes a decrease in quantity supplied.

P0 P1

Q1

Q0

Quantity

Price

An increase in price causes an increase in quantity supplied.

P1 P0

Q0

Q1

Quantity

Price

An increase in supply refers to a rightward shift in the market supply curve.

P0

Q0

Q1

Quantity

Price

A decrease in supply refers to a leftward shift in the market supply curve.

P0

Q1

Q0

Quantity

Balancing supply and demand

 QxS = Qxd Steady-state

Price

D Quantity

Price

7 6 5 Shortage 12 - 6 = 6 6 12 D Quantity

Price 9 8 7

Surplus 14 - 6 = 8

D Quantity

14

Higher demand leads to higher equilibrium price and higher equilibrium quantity.

Higher supply leads to lower equilibrium price and higher equilibrium quantity.

Lower demand leads to lower price and lower quantity exchanged.

Lower supply leads to higher price and lower quantity exchanged.

 The relative magnitudes of change in supply and demand determine the outcome of market equilibrium.

 When supply and demand both increase, quantity will increase, but price may go up or down.

2-60

Price Ceilings
 The maximum legal price that can be charged.

 Examples: Rent control Act. Proposed restrictions on ATM fees.

Price Floors
 The minimum legal price that can be charged.

 Examples: Minimum wage. Agricultural price supports.

2-61

Price PF P*

P Ceiling Shortage Qs Q* Qd D Quantity

2-62

The dollar amount paid to a firm under a price ceiling, plus the nonpecuniary price.

PF = Pc + (PF - PC)

PF = full economic price PC = price ceiling PF - PC = nonpecuniary price

2-63

Ceiling price of gasoline: $1. 3 hours in line to buy 15 gallons of gasoline  Opportunity cost: $5/hr.  Total value of time spent in line: 3 v $5 = $15.  Non-pecuniary price per gallon: $15/15=$1. Full economic price of a gallon of gasoline: $1+$1=2.

For example, ceiling price of apartments: PCeiling = Rs.4,800 per month. Apartment seekers in Bangalore often require the services of a real estate agent or apartment broker to assist them in securing an apartment lease. Typical broker fees are one month's rent. For example, suppose you stay for 4 years, or 48 months. NonNon-pecuniary price per month: Rs.4,800/48 = Rs.100 per month. Full economic price of apartments: Pfull = Rs(4,800+100) = Rs.4,900.

2-65

Price PF P*

Surplus

D Qd QS Quantity

Q*

Full Economic Price The dollar amount paid to a supplier under a price floor, minus the non-pecuniary (non-money) price suppliers loose through their competition to sell the goods. The Full Price falls unless the government supports the price floor.  Minimum wages. PFloor = price ceiling PFull = PFloor + (PFull - PFloor) PFull = full economic price PFull - PFloor = non-pecuniary price

For example, floor price of labor in California: PFloor = $8 per hour. For example, $5 per hour is wasted to get the $8 per hour job.  Dressing for success to work at McDonalds.  Being agreeable or attractive to your boss.  Showing up early and staying late, off the clock. Full economic price of an hour of labor: PFull = $(85) = $3 $(8 per hour.

Demand and supply functions for a product are: Qd = 10,000 4P Qs = 2,000 + 6P If the government imposes a sales tax of Rs.100 per unit, what will be the new equilibrium price?

The supply and demand function for a product is as follows: Qd = 6,000 3P Qs = 3,000 + 4.5P The Government imposes a excise duty of Rs.20 per unit. What is the proportion of tax that is borne by the producer ?