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Sources of Demand

Sources of Demand. MANEC 387 Economics of Strategy. David J. Bryce. Exercise. I will name possible prices for a Reese’s As I name a price, please tell me how many Reese’s you are willing to purchase at that price, right now.

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Sources of Demand

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  1. Sources of Demand MANEC 387 Economics of Strategy David J. Bryce

  2. Exercise • I will name possible prices for a Reese’s • As I name a price, please tell me how many Reese’s you are willing to purchase at that price, right now. • This exercise is an offer to sell and it is real. I reserve the right to call in the cash from any individual at any time who indicates their willingness to buy (you can bring me the cash later if you don’t have it on hand!).

  3. Class Demand For Reese’s Price Quantity Demanded

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

  5. Determinants of Demand • Income • Prices of substitutes • Prices of complements • Advertising • Population changes • Consumer expectations

  6. The Demand Function • An equation representing the demand curve Qxd = f(Px ,PY , M, H,) • Qxd = quantity demand of good X. • Px = price of good X. • PY= price of a substitute good Y. • M = income. • H = any other variable affecting demand

  7. A to B:Increase in quantity demanded A 10 B 6 4 7 Change in Quantity Demanded Price D0 Quantity

  8. What could lead to a change in quantity demanded? • Only a change in price • Why? • Because a given demand curve simply reflects preferences under a given set of conditions—it is a picture of stationary preferences • When conditions change, preferences often do as well, so that the entire relationship of quantity to price also changes (shift in demand)

  9. Change in Demand D0 to D1: Increase in Demand 6 D1 7 Price D0 Quantity 13

  10. What could lead to an increase in demand (shift in demand)? • A change in any of the determinants of demand: • Income • Prices of substitutes • Prices of complements • Advertising • Population changes • Consumer expectations • A change in the quality or characteristics of a product, even if the changes are small

  11. Where do demand curves come from? • Experiments • Raise and lower price systematically over time and watch what happens to quantity • Limitation: hard to control for changes in external factors (you may get a “wiggly” curve!) • Market Research • Surveys in which consumers are asked to tradeoff bundles of goods against price or other bundles in order to determine relative value and demand at given prices • Limitation: Expensive; sampling bias; perception bias—spending real money is different than checking boxes on a survey

  12. Where do demand curves come from? • Regression analysis • Attempt to glean from multiple observations in multiple settings (geographic, store, product, etc.) the relationship between price and quantity • Not always goods that are exactly like • Do not always have observations on the extremes of the curve—extrapolation required • Must control for the amount supplied (otherwise may get an upward sloping demand curve!) • Limitation: Data is hard to get and you must assume that external factors are stable across observations or control for these in the statistics; CAUTION: If you don’t know what you’re doing, you could go wildly astray

  13. Where do demand curves come from? • If all else fails – Use Intuition • “Sniff” the market by looking at how other similar products seem to be doing • Ask your close friends and neighbors how much they would pay • Pray about it (Limitation: faith) • Any other possible qualitative approach you can think of • Believe it or not, you’re likely to get close … and others are doing the same thing in practice • Bottom line: No technique is fool-proof!

  14. Consumer Surplus – the value consumers get from a good but do not have to pay for • “I got a great deal!” • That company offers a lot of bang for the buck! • Dell provides good value. • Total value greatly exceeds total amount paid. • Consumer surplus is large. • “I got a lousy deal!” • That car dealer drives a hard bargain! • I almost decided not to buy it! • They tried to squeeze the very last cent from me! • Total amount paid is close to total value. • Consumer surplus is low.

  15. Consumer Surplus: the value received but not paid for Consumer Surplus: The Discrete Case Price 10 8 6 4 2 D 1 2 3 4 5 Quantity

  16. Value of 4 units Consumer Surplus Consumer Surplus:The Continuous Case Price $ 10 8 6 Total Cost of 4 Units 4 2 D 1 2 3 4 5 Quantity

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