Demand Analysis

1. Managerial EconomicsManagerial Economics
DouglasDouglas - “Managerial economics is .. the - “Managerial economics is .. the
application of economic principles and application of economic principles and
methodologies to the decision-making methodologies to the decision-making
process within the firm or organization.”process within the firm or organization.”

2. SalvatoreSalvatore - “Managerial economics refers to - “Managerial economics refers to
the application of economic theory and the the application of economic theory and the
tools of analysis of decision science to tools of analysis of decision science to
examine how an organisation can achieve its examine how an organisation can achieve its
objectives most effectively.”objectives most effectively.”

3. Positive Economics:-Positive Economics:-
Derives useful theories with testable Derives useful theories with testable
propositions about WHAT IS.propositions about WHAT IS.
Normative Economics:-Normative Economics:-
Provides the basis for value judgements on Provides the basis for value judgements on
economic outcomes.WHAT SHOULD BEeconomic outcomes.WHAT SHOULD BE

4. Scope of Managerial EconomicsScope of Managerial Economics
Utility analysisUtility analysis
Demand and supply analysisDemand and supply analysis
Production and cost analysisProduction and cost analysis
Market analysisMarket analysis
PricingPricing
Investment decisionsInvestment decisions
Game theory Game theory

5. Basic problems of an economyBasic problems of an economy
What to produce( Choice)What to produce( Choice)
How to produce ( Technology)How to produce ( Technology)
Whom to produce ( Distribution)Whom to produce ( Distribution)

6. Fundamental ConceptsFundamental Concepts
Managerial EconomicsManagerial Economics
Marginal PrincipleMarginal Principle
Opportunity cost principleOpportunity cost principle
Incremental PrincipleIncremental Principle
Discount PrincipleDiscount Principle
Time PerspectiveTime Perspective

7. Demand AnalysisDemand Analysis
Demand – Demand –
Desire + ability to pay + willingness to payDesire + ability to pay + willingness to pay
Demand is relative term –Demand is relative term –
PricePrice
TimeTime
PlacePlace

8. Determinants of demandDeterminants of demand
PricePrice
IncomeIncome
Taste, preference and fashionTaste, preference and fashion
Prices of related goodsPrices of related goods
Government policyGovernment policy
Custom and traditionCustom and tradition
AdvertisementAdvertisement

9. Law of demandLaw of demand
If other things remain constant, when price If other things remain constant, when price
increases demand contracts and when price increases demand contracts and when price
decreases demand expands. Price and decreases demand expands. Price and
demand are inversely proportionate.demand are inversely proportionate.

D = a - bPD = a - bP

10. Why demand curve slopes Why demand curve slopes
downwardsdownwards
Law of diminishing marginal utilityLaw of diminishing marginal utility
Income effectIncome effect
Substitution effectSubstitution effect
Multiplicity of usesMultiplicity of uses

11. Market Demand CurveMarket Demand Curve
Shows the amount of a good that will be Shows the amount of a good that will be
purchased at alternative prices.purchased at alternative prices.
Law of DemandLaw of Demand
The demand curve is downward sloping.The demand curve is downward sloping.
Quantity
D
Price

12. Exception to the law of demandException to the law of demand
Giffen GoodsGiffen Goods
Prestigious goodsPrestigious goods
Buyers illusionsBuyers illusions
Necessary goodsNecessary goods
Brand loyaltyBrand loyalty

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

14. Types of Elasticity of demandTypes of Elasticity of demand
Price Elasticity of demandPrice Elasticity of demand
Income elasticity of demandIncome elasticity of demand
Cross Elasticity of demandCross Elasticity of demand
Promotional Elasticity of demandPromotional Elasticity of demand

15. Price elasticity: Price elasticity: EE
pp=%=%DDQ/%Q/%DDPP
Causality: denominator numerator!Causality: denominator numerator!
An An elasticelastic response is one where numerator is greater response is one where numerator is greater
than denominator.than denominator.
i.e., i.e., %%DDQ>%Q>%DDP so P so EE
pp

>1>1
Imagine extreme example.Imagine extreme example.
An An inelasticinelastic response is one where numerator is response is one where numerator is
smaller than denominator.smaller than denominator.
i.e., i.e., %%DDQ<%Q<%DDP so P so EE
pp

<1<1
Again, imagine extreme example.Again, imagine extreme example.

16. Look at the ExtremesLook at the Extremes
Perfectly Elastic DPerfectly Elastic D
EE
pp

==infiniteinfinite
Perfectly Inelastic DPerfectly Inelastic D
P
Q
P
Q
E
p

=0
D
D

17. Relatively Elastic vs. Inelastic Relatively Elastic vs. Inelastic
Demand CurvesDemand Curves

Q
1
Q
2Q
2
’
P
1
P
2
D’
D
D’ is relatively more elastic
than D
P
Q

18. Point Elasticity FormulaPoint Elasticity Formula
Point elasticityPoint elasticity
Point elasticity is Point elasticity is
responsiveness at a point responsiveness at a point
along the demand functionalong the demand function
EE
pp

=D=DQ/QQ/Q
1 1
DDP/PP/P
11
simplifying:simplifying:
EE
pp

=(D=(DQ/Q/D D P)* PP)* P
1 1 /Q/Q
1 1
 Price (Rs.)Price (Rs.)
Q
Q
1
P
1
D

19. Point Elasticity FormulaPoint Elasticity Formula
Point elasticityPoint elasticity
Point elasticity is Point elasticity is
responsiveness at a point responsiveness at a point
along the demand along the demand
functionfunction
EE
pp

=D=DQ/QQ/Q
1 1
DDP/PP/P
11
simplifying:simplifying:
EE
pp

=(D=(DQ/Q/D D P)* PP)* P
1 1 /Q/Q
1 1
 Price (Rs.)Price (Rs.)
Q
Q
1
P
1
D

20. Example: Q=56-0.002*PExample: Q=56-0.002*P
Point elasticityPoint elasticity
EE
pp

=(D=(DQ/Q/D D P)* PP)* P
1 1 /Q/Q
11
SupposeSuppose
P=17000P=17000
Q=56-0.002*17000Q=56-0.002*17000
Q=56-34=22Q=56-34=22
Plug into equation gives:Plug into equation gives:
EE
pp

=(=(-0.002)* 17000-0.002)* 17000
/22 /22
EE
pp

=-34/22=-1.54=-34/22=-1.54
 Price (Rs)Price (Rs)
Q
22
17k
D

21. Arc ElasticityArc Elasticity
Briefly, arc elasticity is simply an Briefly, arc elasticity is simply an
average elasticity along a range of average elasticity along a range of
the demand curve.the demand curve.

22. Arc Elasticity FormulaArc Elasticity Formula
Arc elasticity:Arc elasticity:
Responsiveness along a range of Responsiveness along a range of
D. functionD. function
EE
pp

=D=DQ/((QQ/((Q
11++
QQ
22)/2))/2)

DDP/((PP/((P
11++
PP
22)/2))/2)

simplifying:simplifying:
EE
pp=(D=(DQ/Q/DDP)*((PP)*((P
11+P+P
22)/(Q)/(Q
11+Q+Q
22))))
Price ($)Price ($)
Q
Q
2
P
2
P
1
Q
1
Avg.
responsiveness
D

23. Example Q=56-0.002*PExample Q=56-0.002*P
Arc elasticityArc elasticity
EE
pp

=(D=(DQ/Q/DDP)*((PP)*((P
11+P+P
22)/(Q)/(Q
11+Q+Q
22))))
Look atLook at
P range 16k - 17k P range 16k - 17k
Q=56-0.002*17000Q=56-0.002*17000
Q=56-34=22Q=56-34=22
Plug into equation gives:Plug into equation gives:
EE
pp

=(=(-0.002)*(33000/46)-0.002)*(33000/46)
EE
pp

=-66/46=-1.43=-66/46=-1.43
Price ($)Price ($)
Q
22
17k
D
24
16k

24. Factors influence Price elasticity of Factors influence Price elasticity of
demanddemand
Nature of commodityNature of commodity
Availability of substituteAvailability of substitute
Multiplicity of usesMultiplicity of uses
HabitHabit
Proportion of income spentProportion of income spent
Price rangePrice range

25. Managerial Applications of Price Managerial Applications of Price
elasticity of demandelasticity of demand
Pricing DecisionPricing Decision
Fiscal policyFiscal policy
Labour marketLabour market
International tradeInternational trade

26. Income Elasticity of DemandIncome Elasticity of Demand
Recall demand function is:Recall demand function is:
Q=f(P,Q=f(P,I,PI,P
relatedrelated,Tastes,Buyers,Expectations,Tastes,Buyers,Expectations......))
Change in I causes Change in I causes shiftshift in demand. in demand.
Size of shift depends on income elasticity.Size of shift depends on income elasticity.
EE
I I
=%D=%DQ/Q/%D%DII
Focus again on point formula.Focus again on point formula.
Value of EValue of E
II
determines type of good. determines type of good.

27. Values for Income Elasticity (Values for Income Elasticity (EE
II
))
Sign indicates normal or inferiorSign indicates normal or inferior
EE
II
>0 implies normal good.>0 implies normal good.
EE
II
<0 implies inferior good.<0 implies inferior good.
Normal goods may be Normal goods may be necessitynecessity or or luxuryluxury..
If EIf E
II
>1 then this is luxury (responsive to income).>1 then this is luxury (responsive to income).
If 0<EIf 0<E
II
<1 then this is necessity (unresponsive to <1 then this is necessity (unresponsive to
income).income).

28. Cross Price Elasticity (ECross Price Elasticity (E
XYXY
))
QQ
XX=f(P=f(P
XX , ,I,PI,P
YY,Tastes, Buyers,Expectations,Tastes, Buyers,Expectations......))
Change in Change in PP
YY causes causes shiftshift in demand for X. in demand for X.
Size of shift depends on cross-price elasticity.Size of shift depends on cross-price elasticity.
EE
XYXY
=%D=%DQQ
XX / /%D%DPP
YY
Sign indicates relationship between two goodsSign indicates relationship between two goods
EE
XYXY
>0 implies goods are substitutes. >0 implies goods are substitutes.
EE
XYXY
<0 implies goods are complements. <0 implies goods are complements.

29. OBJECTIVES OF SHORT TERM DEMAND OBJECTIVES OF SHORT TERM DEMAND
FORECASTINGFORECASTING
Production planning Production planning
Evolving sales policy Evolving sales policy
Fixing sales targetsFixing sales targets
Determining price policyDetermining price policy
Inventory controlInventory control
Determining short-term financial planningDetermining short-term financial planning

30. OBJECTIVES OF LONG-TERM DEMAND OBJECTIVES OF LONG-TERM DEMAND
FORECASTINGFORECASTING
BUSINESS PLANNINGBUSINESS PLANNING
MANPOWER PLANNINGMANPOWER PLANNING

LONG-TERM FINANCIAL PLANNINGLONG-TERM FINANCIAL PLANNING

31. METHODS OF DEMAND FORECASTINGMETHODS OF DEMAND FORECASTING
Survey methodsSurvey methods::
Consumer interviewsConsumer interviews
Opinion pollOpinion poll
Experts opinionExperts opinion
End-use methodEnd-use method
Statistical methods:Statistical methods:
Trend AnalysisTrend Analysis
Regression AnalysisRegression Analysis

32. Market Supply CurveMarket Supply Curve
The supply curve shows the amount of a good The supply curve shows the amount of a good
that will be produced at alternative prices.that will be produced at alternative prices.
Law of SupplyLaw of Supply
The supply curve is upward slopingThe supply curve is upward sloping
Price
Quantity
S
0

33. Supply ShiftersSupply Shifters
Input pricesInput prices
Technology or Technology or
government regulationsgovernment regulations
Number of firmsNumber of firms
Substitutes in Substitutes in
productionproduction
TaxesTaxes
Producer expectationsProducer expectations

34. The Supply FunctionThe Supply Function
An equation representing the supply curve:An equation representing the supply curve:
QQ
xx
S S
= f(P= f(P
x x ,,
PP
R R ,W, H,),W, H,)
QQ
xx
S S
= quantity supplied of good X. = quantity supplied of good X.
PP
x x = price of good X.= price of good X.
PP
R R = price of a related good = price of a related good
W = price of inputs (e.g., wages)W = price of inputs (e.g., wages)
H = other variable affecting supplyH = other variable affecting supply

35. Change in Quantity SuppliedChange in Quantity Supplied
Price
Quantity
S
0
20
10
B
A
5 10
A to B: Increase in quantity supplied

36. Price
Quantity
S
0
S
1
8
5 7
S
0
to S
1
: Increase in supply
Change in SupplyChange in Supply
6

37. Producer SurplusProducer Surplus
The amount producers receive in excess of the amount The amount producers receive in excess of the amount
necessary to induce them to produce the good.necessary to induce them to produce the good.
Price
Quantity
S
0
Producer
Surplus
Q
*
P
*

38. Market EquilibriumMarket Equilibrium
Balancing supply and demandBalancing supply and demand
QQ
xx
S S
= Q= Q
xx
dd

Steady-stateSteady-state

39. Price
Quantity
S
D
8
Equilibrium Price and quantity Equilibrium Price and quantity
7

40. Price
Quantity
S
D
5
6
12
Shortage
12 - 6 = 6
6
If price is too low...If price is too low...
7

41. Price
Quantity
S
D
9
14
Surplus
14 - 6 = 8
6
8
8
If price is too high…If price is too high…
7