11-08-2020
Demand & Supply
Demand
1. Desire (to have a commodity / product)
backed by purchasing power and
willingness to pay.
2. Demand refers to the amount of
the good that buyers are willing
and able to purchase ( Mankiw)
1
11-08-2020
Law of Demand
There is an inverse relationship
between the price of a good and
the quantity of the good
demanded per time period, other
things being held constant.
Substitution Effect
Income Effect
Individual Consumer’s Demand
function: QdX = f(PX, I, PY, T)
QdX = quantity demanded of commodity X
by an individual per time period
PX = price per unit of commodity X
I = consumer’s income
PY = price of related (substitute or
complementary) commodity
T = tastes of the consumer
2
11-08-2020
+/- +/- +/-
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
Market Demand Curve
Horizontal summation of
demand curves of
individual consumers
• Bandwagon Effect
• Snob Effect
3
11-08-2020
Horizontal Summation: From
Individual to Market Demand
Market Demand Function
QDX = f(PX, N, I, PY, T)
QDX = quantity demanded of commodity X
PX = price per unit of commodity X
N = number of consumers on the market
I = consumer income
PY = price of related (substitute or
complementary) commodity
T = consumer tastes
4
11-08-2020
Demand Faced by a Firm
• Market Structure
– Monopoly
– Oligopoly
– Monopolistic Competition
– Perfect Competition
• Type of Good
– Durable Goods
– Nondurable Goods
– Producers’ Goods - Derived Demand
Linear Demand Function
QX = a0 + a1PX + a2N + a3I + a4PY + a5T
PX Intercept:
a0 + a2N + a3I + a4PY + a5T
Slope:
QX/PX = a1
QX
Eg. Qx =100-5Px
5
11-08-2020
Price Elasticity of Demand
Q / Q Q P
Point Definition EP
P / P P Q
P
Linear Function EP a1
Q
If Qx =100-5Px ; a1 = ?
7
6 A Ep = -∞
Q=600-100P
5
4
B
C
Price
3 F Ep =1
2
1
0
J Ep =0
0 100 200 300 400 500 600
Q / Q Q P
1. At point B: EP = - (100/1) * (5/100)
P / P P Q
= -1(5/1) = -5
2. At point A: = -(100/1)(6/0) =-∞
3. At point J = -(100/1)(0/6) = 0
6
11-08-2020
Price Elasticity of Demand
Q2 Q1 P2 P1
Arc Definition EP
P2 P1 Q2 Q1
Arc Elasticity is appropriate for analyzing
the effect of discrete changes in price.
For example, a price increase from $1 to $2
could be evaluated by computing the arc
elasticity.
In actual practice, most elasticity
computations involve the arc method.
Example: Consider the NBA Corporation,
which had monthly shoe sales of 10000
pairs (at $ 100 per pair) before a price cut
by its major competitor. After this price
reduction by the competitor, NBA’s sales
declined to 8000 pairs a month. From the
past experience, NBA has estimated the
price elasticity of demand to be about -2.0
in this price-quantity range. If NBA wishes
to restore its sales to 10000 pairs a month,
what price that must be charged ?
7
11-08-2020
Marginal Revenue and Price
Elasticity of Demand
1
MR P 1
EP
TR=p x q; MR= d(pq)
--------
d(q)
dq dp
= p* --- + q* ----
dq dq
q d(p) 1
= p 1 + --- * ---- --
p d(q) Ep
Marginal Revenue and Price
Elasticity of Demand
PX
EP 1
EP 1
EP 1
QX
MRX
8
11-08-2020
Marginal Revenue, Total
Revenue, and Price Elasticity
TR MR>0 MR<0
EP 1 EP 1
QX
EP 1 MR=0
Marginal Revenue, Total Revenue, and Price Elasticity
TR MR>0 MR<0
E P 1 E P 1
E P 1 MR=0
PX QX
EP 1
EP 1
EP 1
QX
MRX
9
11-08-2020
Determinants of Price Elasticity of Demand
Demand for a commodity will be more
elastic if:
It has many close substitutes
It is narrowly defined
Time Factor: More time is available to
adjust to a price change
Nature of the product- necessities are
inelastic; luxury -> elastic, as you can
postpone demand
Greater the Proportion of income spent on
a commodity.
Determinants of Price
Elasticity of Demand
Demand for a commodity will be less
elastic if:
It has few substitutes
It is broadly defined
Less time is available to adjust to a
price change
10
11-08-2020
Income Elasticity of Demand
Q / Q Q I
Point Definition EI
I / I I Q
I
Linear Function EI a3
Q
Income Elasticity of Demand
Q2 Q1 I2 I1
Arc Definition EI
I 2 I1 Q2 Q1
Normal Good Inferior Good
EI > 0 EI < 0
11
11-08-2020
Cross-Price Elasticity of Demand
QX / QX QX PY
Point Definition EXY
PY / PY PY QX
Linear Function PY
E XY a4
QX
Cross-Price Elasticity of Demand
QX 2 QX 1 PY 2 PY1
Arc Definition EXY
PY 2 PY 1 QX 2 QX 1
Substitutes Complements
EXY 0 EXY 0
12
11-08-2020
Other Factors Related to
Demand Theory
• International Convergence of Tastes
– Globalization of Markets
– Influence of International Preferences on
Market Demand
• Growth of Electronic Commerce
– Cost of Sales –> reduces cost of selling,
new methods of sale like auctioning etc
– Supply Chains and Logistics
– Customer Relationship Management
THE CONSTANT- ELASTICITY DEMAND FUNCTION
So far, we assumed that the demand function is linear.
That is, the quantity demanded of a product has been
assumed to be a linear function of its price, the prices of
other goods, consumer income, and other variables.
Another mathematical form that is frequently used is the
constant-elasticity demand function. If the quantity
demanded) depends only on the product's price (P) and
consumer income (I), this mathematical form is:
Q = aP-b1 Ib2 --------------- (1)
Thus, if a = 200, b1 = 0.3, and b2= 2,
Q = 200P-0.3 I2
An important property of this demand function is that the
price elasticity of demand equals b1, regardless of the value
of P or I (This accounts for its being called the constant-
elasticity demand function.)
To see this, differentiate Q with respect to Price:
13
11-08-2020
Q ----------- (2)
= - b1aP-b1-1 Ib2
P b
b1 1* Q
= a P-b1 Ib2 = P
-------- (3)
p
Thus, Q
P
= -b1
---------- (4)
P Q
Constant-elasticity demand function is often used by managers and
managerial economists, for several reasons:
First, in contrast to the linear demand function, this mathematical form
recognizes that the effect of price on quantity depends on the level of
income, and that the effect of income on quantity depends on the
level of price. Thus, multiplicative relationship in equation (1) is often
more realistic than additive relationship in linear equations.
Second, like the linear demand function, the constant-elasticity demand
function is relatively easy to estimate. If we take logarithms of both
sides of equation (1),
logQ = log a - b1 log P + b2log I
Since this equation is linear in the logarithms, the parameters- a, b1,
and b2 can readily be estimated by regression analysis.
Total Outlay(Revenue) Method of Measuring Ep
The picture can't be display ed.
Sl no Price Quantity Total Rev. Ep
(PxQ)
1. 15 200 3000
12 300 3600 Ep>1
2. 15 200 3000
12 250 3000 Ep=1
3. 15 200 3000
12 210 2520 Ep<1
14
11-08-2020
Total Outlay (Revenue) Method of Measuring Ep
Numerical on: MC, Ep,& P
In equilibrium, MC = MR.
1
Hence, MR = MC = P 1 Pe
1
P = MC
1
1
Pe
1
Now, 1) If MC =10, Pe = -2, then P =10
1
1
= 20.0
2
1
2) If MC =10, Pe = -5, then P =10
1
1
= 12.5
5
15
11-08-2020
Complementarities – natural or artificial - make
good business!!
The picture can't be display ed.
The picture can't be display ed.
16
11-08-2020
Impact of tastes/preferences on demand: example:
Tablet sales jump over 400% while desktops stay flat
Pankaj Doval TNN 25 July, 2013
New Delhi: The new-age tablet is apparently gobbling up the PC market. Sales of tablets shot up from just 3.6 lakh
units in 2011-12 to over 19 lakh in the last fiscal, a jump of over 400%, even as desktop PC sales grew by just 1%.
The picture can't be display ed.
The picture can't be display ed.
Latest data released by the Manufacturers’ Association for Information Technology (MAIT) on Wednesday showed
the demand for tablets was driven by users’ desire for apps (applications) to track everything from calories burned
to the weather to navigating the city.
Although India was a late entrant to the world of smart phones and tablets, it now seems to be moving in line with
global trends, with users climbing up the ladder. Smartphone sales went past 1.5 crore units in 2012-13, compared
to over 95 lakh in the previous year. Desktop computer sales was at 67.69 lakh units.
BIG BITE
- 19 lakh tablets sold in 2012-13, up from just 3.6 lakh the year before, a growth of 427%
- Just 1% growth in desktop sales in 2012-13; overall PC market up 5%
- 79% of tablet-buyers owned a PC or Smartphone
- 21% were 1st-time buyers of a computing device
PSUs, govt institutions keep PCs alive But unlike the international market, where PC sales have declined for
straight quarters, institutional demand and purchases in smaller towns is keeping companies in business.
The latest International Data Corporation (IDC) numbers show that PC sales fell almost 14% in January-March
2013, while tablets surged 143% 4.9 crore units. In fact, the first quarter global tablet sales was more than what
was sold during January-June 2012, reflecting skyrocketing demand in emerging markets such as India.
With prices going down, consumers have plenty to choose from. Right from the top-notch Apple iPads that cost
around Rs 50,000 to a gamut of devices from Samsung and then percolating down to home-grown brands like
Micromax and Karbonn, tablets come for as low as Rs 5,000.
A bulk of the desktop PC sales is restricted to government, PSUs and educational establishments, which together
account for as much as 65% of the sales. “In terms of household sales, these are happening in what I would call
the ‘rest of India’, or C-class towns. The metros and B-class towns are no longer major buyers of desktops,” said
Ramamurthy, who now wants a special package from the government to “revive” the PC market. TNN
Market experiment: an example:
The picture can't be display ed.
The picture can't be display ed.
17
11-08-2020
Show the impact of this finding on market demand
using an appropriate diagram
Show the impact of the EU action on Market
Equilibrium using appropriate diagram
18
11-08-2020
1.Suppose the demand for wheat (measured in
quintals) is: Qw = 100000 - 500Pw ; this year’s
harvest is 80000 quintals, where Qw is quantity of
wheat and Pw is price of wheat.
a) What will be total revenue of the farmers this
year?
b) What will happen to farmer’s revenues, if next
year’s harvest were to fall below this year’s
harvest?
2. A firm has estimated the following demand function for its product:
Q = 100 − 5P + 5I + 15A; where Q is quantity demanded per month in
thousands, P is product price, I is an index of consumer income, and A
is advertising expenditures per month in thousands. Assume that
P = $200, I =150, and A = 30. Use the point formulas to complete the
elasticity calculations indicated below.
(i) Calculate quantity demanded and Price elasticity of demand.
(ii) Is demand elastic, inelastic, or unit elastic?
(iii) Calculate the income elasticity of demand. Is the good normal
or inferior? Is it a necessity or a luxury?
(iv) Calculate the advertising elasticity of demand.
19
