MBA(Marketing) Msc(Economics)

INSRUCTOR:BILAL KHAN

Chapter no 2 Utility analysis of Demand

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Terms to know:

The law of demand1

Demand function2

Demand schedule3

Diagramatical representation4

Elasticity of demand7

Changes in Demand 6

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Meaning of demand. Demand is an effective desire which is supported

by willingness and ability to pay for it. The term demand has three components

1. desire 2.Willingness and 3.Ability to pay for or purchasing power.

..

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Quantity demanded is the amount of a good that buyers are willing and able to purchase.

Law of DemandThe law of demand states that, for most goods, other things equal, the quantity demanded of a good falls when the price of the good rises;.

“The demand schedule is a table that shows the relationship between the price of a good and the quantity demanded.”

DEMAND

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The Demand Curve The demand curve is the graphic representation of

the law of demand. The demand curve slopes downward and to the right. As the price goes up, the quantity demanded goes

down.

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Definition:

Law of demand states that, other things remaining the same, amount demanded increases with a fall in price and diminishes with rise in price.

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Definition (continued)

Other things remaining the same

Weather conditionPrice of substitute goods

Taxes of the govt.

Taste, habits of the consumer

Income of the consumer

Political stability

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Demand function:

Qd = f(P) Here,

Qd= Dependent variable

P= Independent variable

Demand has a negative relationship with price; i.e.

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Demand schedule:

price Demand1O0 100O9O 10508O 11007O 115O6O 120O50 125O

price Demand1O0 100O110 950120 900130 850140 800150 750

Decrease in price increase in demand Increase in price decrease in demand

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Diagrammatical representation:

PRICES

Quantity demandO 1000 1050 1100 1150

70

80

90

100 Demand curve

D

D

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Graphical presentation of the LOD schedule.

The above given demand schedule is now shown with the help of graph in which there are two axis vertical and horizontal, with the vertical axis the price of product is given while horizontal axis measures the quantity of that product.

a

b

c

d

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Changes in demand:

Changes in the demand for a commodity can be shown through the demand curve in two ways:

Movements along the demand curve:

Shifts in the demand curve:

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Changes in demand:

CHANGE IN DEMAND:Change in demand

Movement along a demand

curve

Shift in the demand

curve

Extension in demand

Contraction in demand

Increase in demand

Decrease in demand

It is caused by change in the price

alone.

It is caused by changes in factors other than the price.

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Changes in demand (cont’d):

Movements along the demand curve:if the change in demand is due to a rise or fall in the price of a commodity alone, it is known as contraction or extantion in demand.

Quantity

Price

2

4

6

8

100 200 300 400

a

b

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Changes in demand (cont’d):

Shift in the Demand curve: If the changes in demand is due to factor other

than price, it is known as increase or decrease in demand.

In such case the demand curve shift to right or left from the original demand curve.

2

4

6

8

100 200 300 400

The demand curve shift to right due to change in other factors.

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Shift in demand curve

A shift of demand curve can also be caused by a change other than price, such as a change in taste, population, fashion, price of complementary goods, price of substitute goods. For example price of complementary goods, car and oil. If price of car increase it will effect demand of petrol due to which the demand curve of petrol shift downward.

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Shift in Demand Curve

price

Quantity Demand

Demand Curve

D1D2

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Conti This diagram shows shift of demand curve. When price of

complementary product increase or decrease it shift the demand curve upward or downward. Here when the price of car increase it effect the demand of petrol due to which the demand curve shift downward. The diagram shows that when price of petrol was 40 Afs, the demand was 70. but when the price of car increase it effect the demand of petrol due to which the demand decrease to 60 Afs, which shift the curve downward.

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Market Demand vs. Individual Demand

Market demand refers to the sum of all individual demands for a particular good or service.

Graphically, individual demand curves are summed horizontally to obtain the market demand curve.

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Price of Rose Bouquets(RB)

Qty of RB demanded by consumer 1

Qty of RB demanded by consumer 2

Market Demand

$13 0 1 1 $12 0 2 2 $11 1 3 4 $10 2 4 6 $9 3 5 8 $8 4 6 10 $7 5 7 12 $6 6 8 14 $5 7 9 16 $4 8 10 18

$33333

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Terms to know:

statement

Degree/Cases of Ed

Schedule of Ed

Diagrammatical representation

Formula form for Ed

Elasticity Elasticity Of demandOf demand

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Elasticity Elasticity of Demand Meaning and concept. Degrees of elasticity of demand1. Perfectly elastic demand.2. Perfectly inelastic demand.3. High/more elastic demand.4. Less elastic demand and5. Unitary elastic demand. Measurement of demand elasticity. Types of demand elasticity.

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Meaning and concept Elasticity . The term elasticity refers to extension and

contraction quality of a good. For example, rubber, Spring, plastic, metals etc. And a good which has no quality of extension and contraction is known as inelasticity or inelastic good. For instance, stone, paper etc.

Demand elasticity. The LOD expresses only inverse relationship b/w price and quantity demanded but it does not show that how much quantity is influenced by change in price. Only elasticity of demand makes us able to know about that how much quantity is effected by change in price.

Thus demand elasticity is the degree of responsiveness of quantity demanded to change in price. In other words, a percentage change in quantity divided by a percentage change in price is called demand elasticity. Mathematically it is written as

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Elasticity of demand:

Statement: To what extent or to what degree quantity demanded changes as a result of change in price is called elasticity of demand (Ed).

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Cont….

% change in QdEd = % change in price

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DEGREES OF ELASTICITY OF DEMAND.

There are five degrees of demand elasticity which show different level of responsiveness of quantity demanded to change in price these are given as

1. Perfectly elastic demand.2. Perfectly inelastic demand.3. High/more elastic demand. 4. Less elastic demand.5. Unitary elastic demand.

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Explanation to the degrees of demand elasticity. Perfectly elastic demand. A demand is said to be

perfectly elastic when the quantity is increasing or decreasing with no change in price, here in this degree price is constant whereas quantity is variable.

Quantity is influenced by other factors rather than price such as, change in income, taste, price of substitutes etc

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Schedule and graph for PED.

price quantity

10 20

10 30

Y

X0

5

10

10 20 30

..D LP

Q

Here the quantity is effected not by price but by other factors such as change in income, taste, price of substitute etc.

a b

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Perfectly inelastic demand Perfectly inelastic demand refers to no change in

quantity with any change in price, whatever the price is the quantity remain unchanged or fixed. The demand for necessary items is perfectly inelastic such as food, medicine etc.

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Cases/Degrees of elasticity of demand:

Elasticity of Elasticity of demanddemand

Less Less elasticelastic

Equal elasticEqual elastic

More elasticMore elastic

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Cases of Ed (cont’d):

Equal elastic

More elastic

Less elastic

If there is a great change in price cause a less change in quantity demand, is called less elastic situation.

If there is an equal change in price cause an equal change in quantity demanded, is called equal elasticity of demand.

If there is a less change in price caused a great change in quantity demand, is called more elastic situation.

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Schedule form of Ed:

50 2O

40 22

Less elastic

Price Demand

15 100

10 200

More elastic

Price Demand12 60

10 70

Price Demand

Equal elastic

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Diagrammatical representation of less elastic demand:

Less elastic curve

20 22

40

50

PRICE

QUANTITY DEMANDED

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Diagrammatical illustration for equal elasticity:

Equal elastic curve

PRICE

QUANTITY DEMANDED

50 60

10

12

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Diagrammatical illustration for more elasticity:

PRICE

QUANTITY DEMANDED

100 200

10

15 More elastic curve

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Measurement of elasticity (Formula for Ed):

The formula form for elasticity of demand is; Elasticity of demand = change in quantity demanded ÷ change in price Quantity Price

Ed = ΔQd ÷ ΔP Q P Ed = ΔQd × P Q ΔP

Ed = ΔQd × P ΔP Q

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Measurement of demand elasticity.

To measure the elasticity of demand economists use 1 or unit for hundred percent change in quantity to change in price. If the elasticity of demand for a good is lees than 1 the demand is said to be less elastic and if the elasticity of demand is greater than 1 then the demand is said to be more elastic. When the elasticity is exactly equal to 1 then the demand is said to be unitary elastic.

Now to find these degrees of demand elasticity, a mathematical formula is given as under.

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Formula for demand elasticity.The elasticity of demand is to be

measured with the help of given formula.

Ed = ∆q the above given formula is used for

price elasticity of demand only such as, more, less and unitary elastic demand.

∆p×

p

q

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Measurement. 1

Price Quantity p 20 10

12 q12Ed = ∆q × p ∆p q

Ed = 2 × 20 = 10 = .4 8 12 24

Here elasticity of demand is less than 1 which shows that demand is less elastic.

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Measurement. 2

Price Quantity

p100 10

90 q18Ed = ∆q × p

∆p q

Ed = 8 × 100 = 800 = 4.4 10 18 180

Here the elasticity of demand is greater than 1 which shows that demand is more or high elastic.

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Measurement. 3

Price Quantity

100 10

50 20Ed = ∆q × p

∆p q

Ed = 10 × 100 = 1000 = 1

50 20 1000

Here elasticity of demand is exactly equal to 1 which shows that demand is unitary elastic.

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Types of Elasticity of Demand:

There are many types of elasticity of demand: i.e.

Price elasticity of demand Income elasticity of demand and Cross elasticity of demand.

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1) Price Elasticity of Demand:

Price elasticity of demand is percentage change in quantity demanded divided by the percentage change in the price.

P.E = %age change in amount demanded / % change in price.

Suppose the price of a commodity increase from 20 to 25. quantity demand decrease from 50 to 40. which is equal to 5÷10 = 0.5 there for price elasticity of demand is 5%.

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Income elasticity of demand: “Income elasticity of demand is the

responsiveness of demand to changes in the income of the consumer.”

Income elasticity is calculated by using the following formula:

Ey = % change in quantity / % change in income

Ey = ΔQ/Q ÷ ΔY/YEy = ΔQ/Q × Y/ΔY

Types of Elasticity of Demand (cont’d):

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Types of Elasticity of Demand (cont’d):

Income elasticity of demand is:a) Equal to unity i.e. when the proportion of income spent on

goods remains the same even after increase in income.Ey = 1

b) It is less than unity if the proportion decreases.Ey < 1

a) More than unity if the proportion increases.Ey > 1

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Types of Elasticity of Demand (cont’d):

For example:

monthly income of the consumer (Afs)

Monthly demand for meat (Kg)

5000 40

8000 50

Ey = ΔQ/ΔY × Y/QEy = 10/3000 × 5000/40Ey = 0.14Ey = 0.14 < 1

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Types of Elasticity of Demand (cont’d):

Cross elasticity of demand: “The rate of responsiveness of quantity demanded

of commodity A to changes in price of commodity B.” i.e.

EAB = % change in Qd of A ÷ % change in price of BEAB = ΔQA/QA ÷ ΔPB/PB

EAB = ΔQA/QA × PB/ΔPB

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Types of Elasticity of Demand (cont’d):

For example:Price of wheat (PB)

Quantity demand for rice (QA)

200 1000

300 1200

EAB = ΔQA/ΔPB × PB/QA

EAB = 200/100 × 200/1000EAB =2/5 = 0.4<1

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Extension or Contraction of Demand

Extension of Demand: An extension of demand caused by a fall in price. When price decrease demand increase which extend the demand and curve moved upward.

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Extension of Demand

Price

Quantity Demand

P1

P2

D1 D2

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Contraction of demand caused by a rise in price. When price increase demand decrease which is called contraction of demand.

Contraction of demand:

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Contraction of Demand

Price

Quantity Demand

P2

P1

D2

D1

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Demand Curve

The demand curve has a negative slope, consistent with the law of demand.

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Supply Curve

The supply curve has a positive slope, consistent with the law of supply.

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Equilibrium

In economics, an equilibrium is a situation in which: there is no tendency to change, quantity demanded equals quantity supplied,

and the market just clears.

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Equilibrium

Equilibrium occurs at a price of $3 and a quantity of 30 units.

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Shortages and Surpluses

A shortage occurs when quantity demanded exceeds quantity supplied. A shortage leads to increase the price.

A surplus occurs when quantity supplied exceeds quantity demanded. A surplus leads to decrease the price..

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Shortage.

A price is set at $2 resulting in a shortage of 20 units.

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Surplus.

A price is set at $4 resulting in a surplus of 20 units.

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Price Equilibrium:

The equilibrium price the amount that buyers wish to purchase is exactly equal to the amount that supplier are willingly to offer to the market. Simply we can say that the amount at which both buyer and seller are agree. The buyer want to purchase on that price, while supplier is ready to supply that product to the market on that amount.

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Schedule

price Qd Qs 10 80 30 12 70 45 16 60 60 18 50 70 20 40 80

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Diagram 20 18 16

14 12 10 20 40 60 80

100

EPrice

Qd/Qs

E is Equilibrium point

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Explanation

the above schedule and diagram shows various prices of a product and its quantity demand and quantity supply. When the price was 10, the quantity demand of this product was 80 and the supplier supply 30 products to the market. As price increase quantity demand decrease and quantity supply increase. When price increase to 16, at this point the quantity demand and quantity supply both are same, which is call equilibrium price.