Sources of Demand
MANEC 387
Economics of Strategy
David J. Bryce
David Bryce © 1996-2002
Adapted from Baye © 2002
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!).
David Bryce © 1996-2002
Adapted from Baye © 2002
Class Demand For Reese’s
$1.00
Price
$0.75
$0.50
$0.25
$0.00
0
50
100
Quantity Demanded
David Bryce © 1996-2002
Adapted from Baye © 2002
150
Market Demand Curve
• Shows the amount of a good that will
be purchased at alternative prices.
• Law of Demand
– The demand curve is downward sloping.
Price
D
Quantity
David Bryce © 1996-2002
Adapted from Baye © 2002
Determinants of Demand
•
•
•
•
•
•
Income
Prices of substitutes
Prices of complements
Advertising
Population changes
Consumer expectations
David Bryce © 1996-2002
Adapted from Baye © 2002
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
David Bryce © 1996-2002
Adapted from Baye © 2002
Change in Quantity Demanded
Price
A to B: Increase in quantity
demanded
A
10
B
6
D0
4
David Bryce © 1996-2002
Adapted from Baye © 2002
7
Quantity
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)
David Bryce © 1996-2002
Adapted from Baye © 2002
Change in Demand
Price
D0 to D1: Increase in
Demand
6
D1
D0
7
David Bryce © 1996-2002
Adapted from Baye © 2002
13
Quantity
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
David Bryce © 1996-2002
Adapted from Baye © 2002
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
David Bryce © 1996-2002
Adapted from Baye © 2002
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
David Bryce © 1996-2002
Adapted from Baye © 2002
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!
David Bryce © 1996-2002
Adapted from Baye © 2002
Estimating a curve example:
• A retailer wants to know the demand
curve for ties
– Observes that over the past 2 weeks 100
ties have sold at $25
– Reduces price to $20 for next two weeks
without announcement; sells 120 ties
– Reduces price to $15 for following two
weeks; sells 160 ties
David Bryce © 1996-2002
Adapted from Baye © 2002
Estimating a curve example:
Two Week Demand for Ties
$30
$25
$20
Price of
Ties Sold
$15
$10
$5
$0
80
100
120
140
160
Quantity of Ties Sold
David Bryce © 1996-2002
Adapted from Baye © 2002
180
Estimating a curve example:
180
Two Week Demand for Ties
160
140
120
Quantity 100
of Ties
80
Sold
60
Q = -6P + 246.67
40
20
0
$10
$15
$20
$25
Price of Ties Sold
David Bryce © 1996-2002
Adapted from Baye © 2002
$30
Consumer Surplus – the value consumers
get from a good but do not have to pay for
• “I got a lousy deal!”
• That car dealer drives a
That company offers a lot
hard bargain!
of bang for the buck!
• I almost decided not to
buy it!
Dell provides good value.
• They tried to squeeze the
Total value greatly
very last cent from me!
exceeds total amount
• Total amount paid is close
paid.
to total value.
Consumer surplus is large. • Consumer surplus is low.
• “I got a great deal!”
•
•
•
•
David Bryce © 1996-2002
Adapted from Baye © 2002
Consumer Surplus:
The Discrete Case
Price
10
Consumer Surplus: the
value received but not
paid for
8
6
4
2
D
1
David Bryce © 1996-2002
Adapted from Baye © 2002
2
3
4
5
Quantity
Consumer Surplus:
The Continuous Case
Price $
10
Value
of 4 units
8
Consumer
Surplus
6
Total Cost of 4
Units
4
2
D
1
David Bryce © 1996-2002
Adapted from Baye © 2002
2
3
4
5
Quantity