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Kardan University

Kardan University. Kardan.edu.af. Demand. Demand for a good or service is defined as quantities of a good or service that people are ready (willing and able) to buy at various prices within some given time period, other factors besides price held constant. Kardan.edu.af.

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Kardan University

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  1. Kardan University Kardan.edu.af

  2. Demand • Demand for a good or service is defined as quantities of a good or service that people are ready (willing and able) to buy at various prices within some given time period, other factors besides price held constant. Kardan.edu.af

  3. Demand Function • The demand for a commodity arises from the consumers’ willingness and ability to purchase the commodity. Consumer demand theory postulates that the quantity demanded of a commodity is a function of / or depends on the price of the commodity, the consumers’ income, the price of related commodities, and the tastes of the consumer. • Qd = f(p){Y,Pr , T, N} Kardan.edu.af

  4. Change in Quantity Demanded Price An increase in price causes a decrease in quantity demanded. P1 P0 Quantity Q1 Q0 Kardan.edu.af

  5. Change in Quantity Demanded Price A decrease in price causes an increase in quantity demanded. P0 P1 Quantity Q0 Q1 Kardan.edu.af

  6. Changes in demand • Changes in price result in changes in the quantity demanded. • This is shown as movement along the demand curve. • Changes in nonprice determinants result in changes in demand. • This is shown as a shift in the demand curve. Kardan.edu.af

  7. Changes in demand • Nonprice determinants of demand • Tastes and preferences • Income • Prices of related products • Future expectations • Number of buyers Kardan.edu.af

  8. Changes in demand • Change in Buyers’ Tastes -Today’ consumer purchases leaner meats compared to old generations -due to the level of blood cholesterol and body weight • Change in Buyers’ Incomes • Normal Goods i.e., shoes, travel, automobiles, education • Inferior Goods • i.e., potatoes, salt • Change in the Number of Buyers • Change in the Price of Related Goods • Substitute Goods • i.e., Carrots can be replaced by cabbage • Complementary Goods • i.e., cars and gasoline or electric stove and electricity. Kardan.edu.af

  9. Change in Demand An increase in demand refers to a rightward shift in the market demand curve. Price P0 Quantity Q0 Q1 Kardan.edu.af

  10. Change in Demand A decrease in demand refers to a leftward shift in the market demand curve. Price P0 Quantity Q1 Q0 Kardan.edu.af

  11. Mathematically Qdx= f(Px, I, Py, N,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 Kardan.edu.af

  12. Related concepts • The increase in Qx when Px falls occurs because in consumption, the individual consumer substitutes commodity x for other commodities which are now relatively expensive. This is called the substitution effect. • In addition, when Px falls, a consumer can purchase more of x with a given amount of money (i.e., the consumer’s real income increases). This is called the income effect. Kardan.edu.af

  13. To remember.. • Band wagon effect: “ to keep up with the Joneses” “Me too” • Snob Effect: “Me only” Kardan.edu.af

  14. Using elasticity in managerial decision making • Controllable factors • Setting the price of its product • Expenditures on advertisement • Quality of its product • Customer service Kardan.edu.af

  15. Using elasticity in managerial making decision…. continued • Uncontrollable factors • Level and growth of consumer income • Competitor price decisions • Competitors expenditures on advertisement • Competitor’s Product quality and customer service Kardan.edu.af

  16. Price Elasticity of Demand/Demand sensitivity Analysis • Price Elasticity of demand is the measure of the response of the change in the quantity demanded due to the change in the price of the product. • Decision: If demand for a product is price inelastic, the firm would not decrease the price of the product, by doing so the firm would decrease its profit. Ep = ΔQd × P ΔP Q Kardan.edu.af

  17. Mathematically Linear Function Kardan.edu.af

  18. Price Elasticity of Demand- Example • Find Ep at point A, B, C and G • Ep=(ΔQ/ ΔP) (P/Q) • At point A, Ep=(0-200/ 6-5) (6/0) • Ep=-200 (6/0)= - indefinite • At point B, Ep= (200-400/5-4) (5/200)=-5 • At point C, Ep=(400-600/4-3) (4/400)=-2 • At point G =?? Kardan.edu.af

  19. P Q Ep TR=P.Q MR=DTR/DQ (1) (2) (3) (4) (5) $ 6 0 -indefinite $ 0 - 5 200 -5 1,000 5 4 400 -2 1,600 3 3 600 -1 1,800 1 2 800 -1/2 1,600 -1 1 1,000 -1/5 1,000 -3 0 1,200 0 0 -5 MR and TR based on Elasticity- Example Kardan.edu.af

  20. MR>0 MR<0 MR=0 Graphically Showing Elasticities and MR-TR TR QX 0 600 1200 Kardan.edu.af

  21. Graphically Showing Elasticities and MR-TR PX 6 QX 0 600 1200 MRX Kardan.edu.af

  22. Price Elasticity & Firm's Total Revenue P Q Ep TR=P.Q Situation 6 0 ∞ $0 Perfectly Elastic 5 100 5 500 More Elastic 4 200 2 800 More Elastic 3 300 1 900 Unitary Elastic 2 400 0.5 800 Less Elastic 1 500 0.2 500 Less Elastic 0 600 0 0 inelastic Kardan.edu.af

  23. Price elasticity, total revenue, and Demand F 900 TR TR 600 Qd 300 P ($) 6 >1 E 5 P 4 E =1 P 3 2 E <1 P 1 0 600 300 Kardan.edu.af

  24. Reference page 138 • Case study 4-3 (Price elasticity of Demand)

  25. Income Elasticity of Demand Income Elasticity of Demand measure the response of the change-in-quantity-demanded due to the change-in-income of the people. Income elasticity of demand suggests the growth potential of a market. It also shows the nature of good. If Ey = 0 the good is income inelastic and has no potential for the market growth. If Ey= +ve the good is a normal good and is income elastic If Ey= -ve the good is an inferior good and is income elastic Ey = ΔQd × Y ΔY Q Kardan.edu.af

  26. < > > E 0 <E E 1 1 0 I I I Income Elasticity of Demand Inferior Good Normal Good Necessities Good Luxuries Good Kardan.edu.af

  27. Income Elasticity of Demand • Point Definition • Linear Function Kardan.edu.af

  28. Using Income Elasticity in managerial making decision…. continued • Decision: • If income elasticity of demand is very low for the firm’s product is Negative, management must know that firm will not benefit from the rising incomes of the people and may want to improve its product or move into new product line with more income elasticity of demand. Kardan.edu.af

  29. Reference page 140 • Case study 4-4 (income elasticity of demand)

  30. Cross Elasticity of Demand Cross Elasticity of Demand measures the response of the change-in-quantity demanded of a product due to change-in-the price of competitor’s product. Cross Elasticity of demand shows the rivalry of the product. Ecr= +ve the good will be substitute good Ecr=-ve the good will be complimentary good Ecr= 0 the goods are uncorrelated. For Example, Ppepesi increase  Qcoke increases (Substitute good) Pcar increase  Qpetrol decreases (Complimentary Good) Pbutter increase  Qbooks remains the same (Uncorrelated goods) ECr = ΔQa × Pb ΔPb Qa Kardan.edu.af

  31. Cross-Price Elasticity of Demand Point Definition Linear Function Kardan.edu.af

  32. Cross-Price Elasticity of Demand Complements Substitutes Kardan.edu.af

  33. Using Cross Elasticity in managerial making decision…. continued • Decision: • If the firm estimated that cross elasticity of demand for its product with respect to the price of competitor’s product is very high. It will be good to quickly respond to the competitor price reduction ,otherwise, the firm would lose a great deal of its sale. • However the firm would think twice before lowering its price for fear of starting a price war. • For reference: read case application 3-7 p#117, 5thedi. “demand elasiticities for beverages in USA” Kardan.edu.af

  34. Commodity X Commodity Y EXY Substitute Goods: Natural Gas Electricity 0.80 Coke Pepsi 0.40 Tea Coffee 0.29 Complementary Goods: Car Petrol -0.50 Mobile SIM Card -0.72 Pen Ink -0.87 Kardan.edu.af

  35. Commodity X Commodity Y EXY Substitute Goods: McIntosh apple Golden delicious apples 0.80 Apples Apple Juice 0.50 Apples Energy Drinks 0.10

  36. Case Study 4-5 page 143 • 1) Cross elasticity of demand • Case study 4-6 page # 147 • Price ,income and cross elasticities

  37. In case of substitute goods Ed=? Kardan.edu.af

  38. In case of complementary goods Ed=? Kardan.edu.af

  39. Advertising Elasticity of Demand Advertising Elasticity of Demand measure the response of the change-in-quantity-demanded due to the change-in-Advertising expenditures. Decision: If elasticity of sale with respect to advertising is positive and higher than for its expenditures on product quality and customer service then firm must concentrate more on advertising rather than on product quality and customer service. EA = ΔQd × A ΔA Q Kardan.edu.af

  40. Using Elasticises In Managerial Decision Making-Example • A firm selling coffee brand X and estimated relevant demand regression as follows: • Qx=1.5-3.0 Px+0.8I+2.0Py-0.6Ps+1.2A • Qx is sales of coffee brand X, I is disposable income, Py is price of competitive coffee brand, Ps is price of sugar and A is advertising expenditures for coffee brand X. • Suppose: Px=$2, I=$2.5, Py=$1.80, Ps=$0.50 and A=$1 Kardan.edu.af

  41. Using Elasticities In Managerial Decision MakingExample page 145 • Calculate Qx and the elasticities of sales with respect to each variable in the relevant demand function • Qx=1.5-3.0(2)…1.2(1)=2 mn pounds coffee • Calculate the elasticities of the demand for coffee brand X • Ep=-3(2/2)=-3,Ei=0.8(2.5/2)=1, Exy=2(1.8/2) • Exs=-0.6(0.5/2)=-0.15, Ea=1.2(1/2)=0.6 • RECALL the Formulae Kardan.edu.af

  42. Using Elasticises In Managerial Decision Making-Example • Next year, the firm would like to increase Px by 5%, A by 12%, I by 4%, and Py 7% whereas Ps fall by 8%. • Determine sales of coffee brand X in the next year. • Qxx=Qx+Qx(DPx/Px)Ep……+Qx(DA/A)Ea • Qxx=2+2(5%)(-3)…..+2(5%)(0.6) • Qxx=2.2 or 2,200,000 pounds Kardan.edu.af

  43. Question Given the demand for beef in the country. Qd= 4850 – 5Pb + 1.5Pc + 0.1Y Y = National Income = 10,000 Pb= Price of Beef = 200 Pc = Price of Chicken =100 Find the Following Elasticities of Demand for Beef in the Country: a. Price Elasticity of Demand b. Income Elasticity of Demand c. Cross Elasticity of Demand. Kardan.edu.af

  44. Thanks Kardan.edu.af

  45. The important steps by using Elasticities • The analysis of the forces or variables that affect on demand and reliable estimates of their quantitative effect on sales (elasticities) are essential in order for firm to make best operating decisions in shor-run and to plan for its growth in the long-run. • The firms can use the elasticities of demand of the variables under their controls to find out best policies as well as to maximize their profits. • If the demand for the firm’s product is price inelastic, the firm will want to increase the product price since that would increase its total revenue and reduce its total cost. • If the elasticity of the firm’s sales wrt the variable beyod its control or If the cross-price elasticity of demand for the firm’s product is very high, the firm will need to respond quickly to a competitor’s price reduction otherwise losing a great deal of itssales. Kardan.edu.af

  46. The important steps by using Elasticities • The size of the price elasticity of demand is larger, the closer and the greater is the number of available substitutes for the commodity. For example, sugar is more price elastic than table salt (e.g. honey) • In general, the greater is its price elasticity of demand, the greater will be the number of substitutes • For a given price change, the quantity response is likely to be much larger in the long run than short run so the price elasticity odf demand is likely to be much greater in the long run than short run . Kardan.edu.af

  47. The demand faced by a firm (cont….) • Following forces effect the demand of a firm. • Own Price of the product • Consumer income & taste • Price of related goods • Numbers of consumers in market • Level of Advertisement and promotional policies • Availability of credit in the country Kardan.edu.af

  48. Mathematically…. QD=F(P, Y , Pr ,T, A, etc) Where as Qd=Quantity demand of commodity X P=Price of commodity X Y= Income of the household Pr=Price of related goods (substitutes or complementary) T=Taste of consumer A= Advertising Kardan.edu.af

  49. Results • 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 Substitutes Complements

  50. > > < E E 0 <E 0 1 1 I I I Inferior Good Normal Good Necessities Good Luxuries Good

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