Final Draft of M.E DEMAND (1)

8/21/2019 Final Draft of M.E DEMAND (1)

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THEORY OF

DEMAND


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WHAT IS DEMAND?Dem and means desire/want for something but in economics

demand refers to effective demand i.e the amount buyers are

willing to purchase at a given price over a given period of time.

Features:

Demand is desire/want backed by money. (Demand=desire + ability topay + will to pay)

Demand is always related to price and time (ex-demand for oranges by a

household at a price of Rs. 50/kg is 5 kg oranges/week.)

Demand may be viewed as Ex Ante (intended/potential demand) or Ex

Post (amt actually purchased/actual quantity demanded)


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DETERMINANTS OF DEMAND

Price of Product

Income of Consumer

Price of Related Good

Tastes and Preferences

Advertising

Consumers expectation of future Income and Price Growth of Economy

Seasonal conditions

Population

When we express the relationship betweendemand and its determinants mathematically, therelationship is known as demand function.

Dx= f (Px, Y, Po, T, A, Ef, N )


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DEMAND SCHEDULE AND

DEMAND CURVE

The geometrical representation of demand

schedule is called the demand curve.


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WHY DEMAND THEORY FOR

MANAGERS??

Consumer demand is the basis of all productive activities.

Just as necessity is the mother of invention, demand is

the mother of product ion. Increasing demand for a

product offers high business prospects for it in future and

decreasing demand for a product diminishes its businessprospect. For example, increasing demand for computers,

cars, mobile phones etc. in India has enlarged the business

prospect for both domestic and foreign companies selling

these goods. On the other hand, declining demand forblack and white TV sets and manual typewriters is forcing

heir companies to switch over to modern substitutes or else

go out of business.


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It is therefore, essential for business managers to have a

clear understanding of the following aspects of demand fortheir products:

(i) What is the basis of demand for a commodity?

(ii) What are the determinants of demand?

(iii) How do the buyers decide the quantity of a product to

be purchased?

(iv) How do the buyers respond to change in product

prices, their incomes and prices of the related goods?(v) How can the total or market demand for a product be

assessed and forecasted?


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BASIS OF DEMAND- UTILITY

The concept of utility can be looked upon from two

angles. First from the commodity angle, ut i l i ty is the

want-sat is fy ing property of a commod ity. Second

from the consumers angle, ut i l i ty is the psycho logical

feel ing o f satisfact ion, pleasu re, happ iness o r wel l

being wh ich a consumer der ives from the

consump t ion, possess ion or the use of a

commod i ty.


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TOTAL UTILITY

TOTAL UTILITY: - The concept of cardinal utility makes it possible

to define the Total and Marginal Utility in quantitative terms. The

total utility (TU), with reference to a single commodity, may be

defined as the sum of the utility derived from all the units consumed

of the commodity. For example, it a consumer consumes 4 units of

a commodity and derives U1, U2, and U3 band U4 utils from thesuccessive units consumed, then

TU=U1+U2+U3+U4

If he consumes n units the total utility (TU) from n units can be

expressed as

TUn =U1+U2 +U3+...+UN


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MARGINAL UTILITY

MARGINAL UTILITY: - One, marginal utility is the utility derived from the

marginal or the last unit consumed.

Two, marginal utility ism the addition to the total utility- the utility

derived from the consumption or acquisition of one additional unit, Or,

Marginal Utility (MU) is the change in the total utility resulting from the

change in the consumption. Thus, MU + ATU

AQ

Where ATU = change in total utility, and AQ = change in quantity consumed

of a commodity.

Three, marginal utility (MU) may also be expressed as

MU =TUnTun-1


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CARDINAL APPROACH

CARDINAL UTILITY THEORY: -Consumer equilibrium

is a situation in which a consumer has allocated his

given income on different available commodities in such

a manner that he gets the highest possible utility. He will

not like to change from his situation.

Cardinal approach to the determination of consumer

equilibrium postulates that utility can be measured. The

utility can be measured by the monetary units (i.e. the

amount of money) that the consumer is prepared to payfor another unit of the commodity.


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THE LAW OF DIMINISHING MARGINAL

UTILITY The law of diminishing marginal utility is central to the cardinal utility

analysis of the consumer behavior. This law states that as the quantityconsumed of a commodity increases per unit of time, the utility derived by

the consumer from the successive units goes on decreasing, provided the

consumption of all other goods remains constant. This law stems from the

facts

That the utility derived from a commodity depends on the intensity or

urgency of the need for that commodity, and

That as more and more quantity of a commodity is consumed, the intensity

of desire decreases and therefore the utility derived from the marginal unit

decreases.

For example, suppose you are very hungry and are offered burgers to eat.

The satisfaction, which you derive from the first piece of burger, would be

the maximum because intensity of your hunger goes on decreasing and

therefore the satisfaction that you derive from the successive units goes on

decreasing. This phenomenon is generalized in the form of a theory call the

Law of Diminishing Marginal Utility.


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Total and Marginal Utility

Burgers Total Utility (TU) Marginal Utility

0

0

0

0 = 0

1 30 30 0 = 30

2 50 50 30 = 20

3

60

60 50 = 10

4 65 65 60 = 5

5

65

65 65 = 0

6

60

60

65 = -5

Totalutility

Maximum TU

Burgers consumed per unit of time

30

20

10

x

Y

Marginal

Utility

Burgers

Consumed Per

Unit of Time

MU

Y

X

0


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CONSUMERS EQUILIBRIUM

A consumer reaches equilibrium position, when he

maximizes his total utility given his income and prices of

commodities he consumes. Analyzing consumers

equilibrium requires answering the question as to how a

consumer allocates his money income between the

various goods and services he consumers to maximize

his total utility.

Before we proceed, let us describe the assumptions of

the Marshalling approach to the determination of

consumers equilibrium.


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ASSUMPTIONS:

Rationality.

Limited Money Income.

Maximization of Satisfaction.

Utility is Cardinally Measurable.

Diminishing Marginal Utility.

Constant Utility of Money.

Utility is Additive


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INDIFFERENCE CURVE ANALYSIS :

ORDINAL UTILITY APPROACH

Definition :

An indifference curve is the locus of points representing all

the different combinations of two goods which yield equal

level of utility to the consumer.

Indifference Schedule :

Indifference schedule is a list of various combinations of

commodities which are equally satisfactory to theconsumer concerned.


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Assumptions

Rational behavior of the consumer

Utility is ordinal

Diminishing marginal rate of substitution

Consistency in choice

Transitivity in choice making

Goods consumed are substitutable


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Indifference Schedule:

Combinations Apples Mangoes

A 15 1

B 11 2

C 8 3

D 6 4

E 5 5


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Indifference curve IC shows all possible combinations of apples and

mangoes between which a person is indifferent. Point A shows

consumption bundle consisting of 15 apples and one mango. Moving

from point A to Point B, we are willing to give up 4 apples to get asecond mango (total utility is the same at points A and B).

ED

C

B

A

0

2

4

6

8

10

12

14

16

0 1 2 3 4 5 6

Mangoes

Apples

IC


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Indifference Map :A graph showing a whole set of indifference curves is called an

indifference map. All points on the same curve give equal level of

satisfaction, but each point on higher curve gives higher level ofsatisfaction.

0

5

10

15

20

25

0 1 2 3 4 5Mangoes

Apples

IC

IC2

IC3


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Properties of indifference curves :

Indifference curves are negatively slopedGiven a combination of commodity X and commodity Y, with every

increase in X, the amount in Y should fall in order that the level of

satisfaction from every combination should remain the same.

Indifference curves are convex to the originConvexity illustrates the law of diminishing marginal rate of substitution.

Indifference curves can never intersect each otherIndifference curves can never intersect each other because each

indifference curve represents a specific level of satisfaction. If two

indifference curves intersect each other, then at the point of

intersection, the consumer is experiencing two different levels of utility.


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Consumer Equilibrium

A consumer seeks a market basket that generates the maximum

level of happiness. However, ones money income and prices of

goods imposes a limit on the level of satisfaction that one mayattain. Thus, the income at the disposal of the consumer in

conjunction with prices of the commodities will determine the

budgetary constraint or the price line.

IC

Price Line

0

2

4

6

8

10

12

14

0 5 10 15 20

Mangoes

A

pples

E


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Consumer equilibrium is attained when, given his budget constraint,the consumer reaches the highest possible point on the indifferencecurve. The maximum satisfaction is yielded when the consumer

reaches equilibrium at the point of tangency between an indifferencecurve and the price line. At point E, the price line is tangent to theindifference curve.

At the equilibrium point, slope of indifference curve = slope of priceline

slope of indifference curve = MRS

slope of price line = PX / PY

Thus, at point E, MRS = PX / PY

Thus, satisfaction is maximized when the marginal rate ofsubstitution of X for Y is just equal to the price of X to the price of Y.


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LAW OF DEMAND

As the price of a good rises, quantity

demanded of that good falls.

As the price of a good falls, quantity

demanded of that good rises.

Ceteris paribus.


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EXCEPTIONS TO THE LAW OF DEMAND

Inferior Goods

Snob Appeal

Demonstration Effect Future Expectation of Prices

Insignificant proportion of income spent

Goods with no Substitutes


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CHANGE IN DEMAND VS. CHANGE IN

QUANTITY DEMANDED

A shift of the entire

demand curve to a

new position is called

change in demand. Changes in non-price

determinants of

demand.

Fluctuations in price,

another determinant

of demand, cause

movement along thedemand curve.


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Why the demand curve slope

downwards?

Law of diminishing marginal utility.

Income effect.

Substitution effect.

New consumers.

Multiple use of commodity.


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PRICE ELASTICITY OF DEMAND

The price elasticity of demandis the percentage

change in quantity demanded divided by the percentage

change in price.

Price elasticity of demand =Percentage change in quantity demanded

Percentage change in price


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DEMAND FORECASTING BY THE MANAGERS:

Demand forecasting is predicting the future

demand for the firms product. The knowledgeabout the future demand for the product helps

a great deal in the following areas of business

decision making:Planning and scheduling production.

Acquiring inputs( labour, raw material and

capital)

Making provision for finances

Formulating pricing strategy

Planning advertisement.


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STEPS IN DEMAND FORECASTING

1. Specifying the objectives.

2. Determining the time perspective.3. Making choice of method for demand forecasting.

4. Collection of data and data adjustment.

5. Estimation and interpretation of results.

TECHNIQUES USED:

Survey methodsStatistical methods


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Final Draft of M.E DEMAND (1)

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