2. Demand Estimation
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DEMAND ANALYSIS DEMAND Demand for a commodity implies three things : (A) desire to acquire it (B) willingness to pay for it, and (C) ability to pay for it. The term demand becomes meaningful only when it has a reference to ‘a price’, ‘a period’, and ‘a place’.
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Transcript of 2. Demand Estimation
DEMAND ANALYSIS
DEMAND
Demand for a commodity implies three things :
(A) desire to acquire it (B) willingness to pay for it, and (C) ability to pay for it.
The term demand becomes meaningful only when it has a reference to ‘a price’, ‘a period’, and ‘a place’.
DETERMINANTS OF DEMAND
1. Price of the product (Px)2. Income of the Consumer (Y)3. Price of the related goods, substitutes or
compliments (Pr)4. Taste and Preference of the consumer (T)5. Fashion and Habits (F)6. Weather and Climate (W)7. Customs and Religious Practices (C)8. Advertisement (A)9. War and Emergencies (WE)10. Number of Consumers in the market (P)11. Consumer’s Expectation with regard to
future price (Sp)12. Changes in the Propensity to consume
(PC)13. Income distribution etc. (I)
TRADITIONAL THEORY OF DEMAND
Four determinants - price of the commodity, other prices, income and tastes.
It examines only the final consumer’s demand for durables and non-durables.
It examines the demand in one market in isolation.
It does not deal with the demand for investment goods and intermediate goods.
DEMAND FUNCTION
The demand function for a product explains the quantities of a product demanded due to different factors in the market at a particular period of time.
Dx = f (Px,Y,Pr,T,F,W,C,A, WE, P,Sp,PC ,I) Px = Price of the Product x. Y = Income of the consumer Pr = Price of the related goods T = Taste and Preferences of consumer F = Fashion and habits W= Weather and climate
LAW OF DEMAND
The Law states that “ higher the price, lower the demand and vice versa, other things remaining the same”
Price Qty DemandedRS. 5 80 UnitsRs. 4 100 Units Rs. 3 150 UnitsRs. 2 200 Units
Demand Schedule Demand Curve
EXCEPTIONS TO THE LAW OF DEMAND
1. Giffen’s Paradox2. Veblen Effect3. Fear of shortage4. Ignorance5. Speculation6. Conspicuous necessaries
DEMAND DISTINCTIONS
1. Autonomous demand and Derived demand
2. Perishable and Durable goods demand
3. Consumer’s goods and Producer’s goods demand
4. Company demand and Industry demand
5. Demand by total market and by Market segments
EXTENSION AND CONTRACTION OF DEMAND
Price (£)
Quantity Demanded (000s)
Demand
£10
£5
100 150
The demand curve slopes downwards from left to right (a negative slope) indicating an inverse relationship between price and the quantity demanded. Demand will be higher at lower prices than at higher prices. As price falls, demand rises. As price rises, demand falls.
A
B
C
Extension
Contraction
INCREASE IN DEMAND AND DECREASE IN DEMAND
Price (£)
Quantity Demanded (000s)
Demand
£10
100
D1
D2
10 200
Changes in any of the factors affecting demand other than price cause the entire demand curve to shift to the left (less demanded at each price) or to the right (more demanded at each price).
IncreaseDecrease
ELASTICITY OF DEMAND
Alfred Marshall who developed this concept defined it as “ The elasticity (or responsiveness) of demand in a market is great or small according as the amount demanded increases much or little for a given fall in price and diminishes much or little for a given rise in price.”
PRICE ELASTICITY OF DEMAND The price elasticity means the degree of
responsiveness or sensitiveness of quantity demanded of a commodity to a change in price.
Degrees of Price Elasticity1. Perfectly Elastic Pe = ∞2. Perfectly Inelastic, Pe = 03. Relatively Elastic, Pe > 14. Relatively Inelastic, Pe < 15. Unitary Elastic, Pe = 1
INCOME ELASTICITY OF DEMANDIncome Elasticity of demand is the ratio of proportionate change in the quantity demanded of a commodity to a given proportionate change in the income of the consumer. Income elasticity of (Ie) for a commodity is given by the formula.
Degrees of Income Elasticity Zero income elasticity Negative income elasticity Unitary income elasticity Greater than one Less than one
ADVERTISING OR PROMOTIONAL ELASTICITY OF DEMAND
It refers to the responsiveness demand to change in advertising or other promotional expenses.
FACTORS DETERMINING ELASTICITY OF DEMAND1.Nature of the commodity : - The demand for
luxury goods is highly elastic while the demand for necessaries is generally inelastic.
2.Extent of use :- A commodity having variety of use has relatively elastic demand while a commodity having a specific use has relatively inelastic demand.
3.Substitutes :- The larger the substitutes a commodity has, the larger is the price elasticity of demand.
4.Proportion of income spent on the commodity : - If a person spends only a small part of his income on a commodity, his demand does not change much for price changes. Ex:-salt. Hence demand for such commodity is inelastic.
5. Durability : - Durable goods have high elasticity, whereas the perishable goods are less elastic.
MEASUREMENT OF ELASTICITY
1. Total Expenditure or Total Outlay Method
2. Measuring Elasticity at a point.3. Arc method of finding elasticity
of demand.4. Mathematical method.
DEMAND ESTIMATION1. The demand function for beer in a cityQd = 400 -4p, If P = Rs 10, 15, 12, 20, 25, 30 2. Qd = 1500 - 0.03p + 0.09AE, AE=Rs.10,000P = Rs. 10000, 9000, 8000, 7000 and 6000.3. The generalized linear demand for good X is
estimated to be Q = 250,000 – 500P – 1.50M – 540PR where P is the price of good X, M is average
income of consumers who buy good X, and PR is the price of related good R. The values of P, M, and PR are expected to be $200, $60,000, and $100, respectively. Use these values at this point on demand to make the following computations.
(a) Compute the quantity of good X demanded for the given values of P, M, and PR.
THE GENERALIZED LINEAR DEMAND FOR GOOD X IS ESTIMATED TO BE Q = 50,000 – 500P (b) Calculate the price elasticity of demand
(Pe) At this point on the demand for X, when P= 10 and Q =60, Is demand elastic, inelastic, or unitary elastic? How would increasing/decreasing the price of X affect total revenue? Explain.
Total OutlayPrice (Rs)
Quantity Total Outlay
Value of Price Elast
Nature of Elasticity
10 10 100 Pe < 1 Relatively Inelastic8 12 96
6 16
4 24
2 25
1 60
USES OF ELASTICITY
Pricing – Increase or decrease in price. Managing cash flows. Impact of changes in competitors’
prices. Impact of economic booms and
recessions. Impact of advertising campaigns. And lots more!
