Demand Susantha Bandara Weerakoon BSC(MIS), MBA(ISM), PHD (Business Psychology) Demand is the different quantities that consumers are willing and able to buy at different price levels. Demand is one of the most popular and main topics in microeconomics. Below are some of the factors that must be met for effective demand. ο· ο· ο· Desires to buy Purchasing power Plan to buy Determinants of demand Determinants of demand are the factors that influence demand and those factors influence demand either positively or negatively. Market behavior can be better understood by identifying the strength or weaknesses of these determinants. Price of desired good (Px) This is a very important and strong determinant of demand. Considering only the price factor among the factors that determine the demand, there is an inverse relationship between the price and the quantity demanded of the product. This means that consumers buy fewer quantities at higher prices and more quantities at lower prices. Consumer Income (Y) The next most important factor to consider is the customer's income. There is a positive relationship between consumer income and demand. Whether the product purchased by the customer is a normal product or a luxury product or otherwise an inferior product is also determined based on the customer's income. The relationship of consumer income with respect to luxury goods, normal goods, and inferior goods will discuss in chapter 3. Price of other goods (P1-n) Substitutes and complementary goods are other goods. Another good that can be used as an alternative to one good is called a substitute good. There is a positive relationship between the price of substitute goods and the quantity demanded of the desired good. When the price of a substitute product falls, a group of consumers who have consumed the desired product will shift to the substitute goodS. Similarly, when the price of substitute goods rises, a group of consumers who have consumed the substitute goods will shift to the desired goods There is a negative relationship between the price of a complementary good and the quantity demanded of the desired good. This means that as the price of a complementary good increase, the demand for the desired good decreases. In the same way, when the price of the complementary good decreases, the quantity demanded of the desired good increases. Taste and preference (T) This is another significant determinant of demand. If consumers don't like a good or consider it necessary, they won't demand much of it, regardless of price. Factors such as fashion and fashion trends affect demand by influencing what consumers consider desirable. If consumers expect the price of a good will decrease in the future, the demand for that good will decrease in the present. Similarly, if consumers expect the price of a good will increase in the future, the demand for the good now increases. Theory of demand. Demand theory explains that demand depends on the factors that determine the demand mentioned above. Here all the factors that determine demand are treated as independent variables and demand as dependent variables. Here a change in any independent variable will cause demand to change. The theory of demand can be presented as a function as follows π ππ₯=π (ππ₯ , π1−π , π, π, πΈ, π ……….π) ππ₯π – Demand f – Function ππ₯ - Price of desired good π1−π – Price of related goods Y – Consumer income T – Taste E – Future expectation N – Number of customers O – Other factors Law of demand. Before understanding the law of demand, it is important to understand the concept of the ceteris paribus.” Ceteris paribus is a Latin term which means “all other variables are remaining unchanged”. Ceteris Paribus is used to assume that only one of the variables changes when there are many dependent variables for a change in an independent variable. As we understand in the theory of demand and demand function, there are many factors to determine demand. As the law of demand considers only the price, all other factors except the price of the desired good are assumed to be fixed. The law of demand describes buying fewer quantities when the price rises and buying more quantities when the price falls, while all other factors except the price are constant. This situation, interpreted by the law of demand, can be represented in several ways. Demand schedule: The demand schedule is the tabular representation of the relationship between price and the quantity demanded. Price (GBP) 5 10 15 Quantity Demanded 150 100 50 Demand Curve: The demand curve is the graphical representation of demand law. Here the vertical axis is used for the independent variable (price) and the horizontal axis is used for the dependent variable (quantity demanded). The demand curve is downward sloping due to the inverse relationship between the price and the quantity demanded of the desired good. zero price. Where the demand curve touches the vertical axis (intercept of the price axis) represents the price where the quantity is zero. Demand equation: The demand equation is an algebraic expression that shows the relationship between the price of a good and the quantity demanded. Each demand curve or schedule has its own demand equation. Below is the standard algebraic expression showing the relationship between price and demand. ππ· = π − ππ ππ· = ππ’πππ‘ππ‘π¦ π·πππππππ π = πΌππ‘ππππππ‘ ππ ππ’πππ‘ππ‘π¦ ππ₯ππ π = πππππ ππ ππππππ ππ’ππ£π π = πππππ How to construct a demand equation? Let’s build a demand equation for the below schedule. Price (GBP) 5 10 15 If this demand curve is extended further, it touches the vertical axis and the horizontal axis. The point where the horizontal axis touches the demand curve (intercept of the quantity axis) is called quantity at Quantity Demanded 150 100 50 Step 01:- find the value of π using the below formula. π= βπ βπ π = π ππππ ππ π‘βπ ππ’ππ£π βπ = πΆβππππ ππ ππ’πππ‘ππ‘π¦ ππππππππ βπ = πΆβππππ ππ π‘βπ πππππ Will consider the first two prices π= 100 − 150 15 − 10 π= −50 5 π = −10 Step 02: Substitute the value of b with some price and quantity and find its value. The quantity demanded under 5 GBP is 150. And the value of b is -10. The standard demand equation is QD = a – bp. ππ· = π − ππ 150 = π − 10(5) Exercise: 1. Consider the below demand schedule Price GBP Quantity Demanded 70 100 120 105 Build the demand equation for the above schedule. 2. Demand equation for a certain good is QD = 110 – 5p Construct the demand schedule by considering prices as 14 GBP and 18 GBP. 3. Using the above equation in question no 2, find the price when the quantity demanded is equal to 0. Answers: βπ 150 = π − 50 1. π = βπ = −π = −50 − 150 ππ· = π − ππ 15 30 = 0.5 Step 3: write the equation 120 = π − 0.5(70) 120 = π − 35 −π = −120 − 35 π = 155 QD = 200 – 10p ππ· = 155 − 0.5π −π = −200 π = 200 If you want to find the quantity demanded under 7 GBP, substitute 7 to P in the equation as follows. QD = 200 – 10 x 7 QD = 200 – 70 QD = 130 2. Quantity demanded under 14 ππ· = 110 − 5π ππ· = 110 − 5 (14) = 40 Quantity demanded under 18 ππ· = 110 − 5(18) = 20 Price GBP 14 18 Quantity Demanded 40 20 3. Price when Quantity demanded = 0 ππ· = 110 − 5π 0 = 110 − 5π 5π = 110 110 π= = 22 5 Price when quantity demanded = 0 is 22 GBP Determinants of demand law. We have already recognized that the law of demand is to buy more when the price is low and buy less when the price is high. There are two main reasons for this behavior of the consumer. Income effect: As the consumer's monetary income rises, so does his real income. Real income represents the purchasing power of the consumer. In other words, real income is expressed in terms of the number of goods and services that can be purchased at the expense of this monetary income. Due to these reasons, there is less buying at higher prices. Similarly, when the price decreases, the purchasing power of the consumer increases. Due to this, more purchases are made at lower prices. Substitution effect: Shifting of a consumer from a substitute good to a desired good when the price of a substitute good rises. Shifting consumers from a substitute good to the desired good when the price of a desired good decreases or shifting consumers from desired good to a substitute good when the price of desired good increases is known as the substitution effect. due to this substitution effect, consumers are buying lower quantities at higher prices and more quantities at lower prices. Individual demand and market demand. The demand made by individual consumers and individual firms for a particular good at different prices is called individual demand. So far our focus has also been on an individual demand. The sum of the demands of all individual consumers is called market demand Price 10 15 30 Individual demand Customer A Customer B 25 20 15 30 25 20 Market Demand 55 45 40 Elasticity of demand Measurement of Price elasticity. The measurement of the percentage changes in quantity demanded as a result of the percentage change in a factor that determines demand is called the elasticity of demand. The price elasticity of demand can be calculated in two main ways Here, price, income, and prices of related goods are also decisive factors, so three main types of demand elasticity can be identified. ο· ο· ο· Price Elasticity of Demand Income elasticity of Demand Cross elasticity of demand. Price Elasticity of Demand. Price elasticity of demand is the responsiveness of the quantity demanded of a good to a change in the price of that good. Quantity demanded response to a change in price by different percentages. The value obtained by measuring this is called the coefficient of elasticity. Elasticity Perfect inelastic Demand Inelastic Demand Unitary Demand Elastic Demand Perfectly elastic Demand Value of coefficient 0 Less than 1 Equal to 1 Greater than 1 Infinite 1. Point Elasticity of Demand (PED) The elasticity of demand is calculated at a single point on the demand curve Method 01 ππΈπ· = πππππππ‘πππ πβππππ ππ ππ’πππ‘ππ‘π¦ πππππππ‘πππ πβππππ ππ πππππ Example: Price Quantity GBP Demanded 14 40 18 20 Calculate the point elasticity of demand. 20 − 40 × 100 −50 ππΈπ· = 40 = = −1.75 18 − 14 28.5 14 × 100 The price elasticity of demand is always a negative value due to the inverse relationship between price and the quantity. Method 2: ππΈπ· = ππΈπ· = βπ π × βπ π 20 14 × = −1.75 4 40 In a downward sloping demand curve, the slope of the demand curve is the same at any point and the elasticity of demand is different at each point. ππΈπ· = 50 0 × =0 10 200 In a downward-sloping demand curve, the following conclusions can be drawn about the elasticity of demand The elasticity of point a is Perfect elastic. ο· PED of point 0 ο· ππΈπ· = ππΈπ· = βπ π × βπ π 50 40 × =∝ 10 0 PED at point b βπ π ππΈπ· = × βπ π ππΈπ· = 50 30 × = −3 10 50 PED at point c ππΈπ· = ππΈπ· = βπ π × βπ π 50 20 × = −1 10 100 ππΈπ· = βπ π × βπ π 50 10 × = −0.33 10 150 PED at Point e ππΈπ· = ο· Arc elasticity of demand,(AED) The arc elasticity of demand calculates the elasticity of demand between two points of the demand curve. A moderate value is taken in the price and quantity of the two points to be considered. π1 + π2 βπ 2 π΄πΈπ· = × βπ π1 + π2 2 This formula further can simplify as PED at point d ππΈπ· = ο· The elasticity of point b is elastic The elasticity of point c is unitary The elasticity of point d is inelastic The elasticity of point e is perfectly inelastic π΄πΈπ· = We will consider points B and c calculate arc elasticity. π΄πΈπ· = βπ π × βπ π Δπ π1 + π2 × Δπ π1 + π2 Δπ π1 + π2 × Δπ π1 + π2 π΄πΈπ· = 50 20 + 30 × 10 100 + 50 50 50 π΄πΈπ· = × 10 150 π΄πΈπ· = 50 50 × = 1.66 10 150 Perfectly inelastic demand The price elasticity of demand for a good to be perfectly inelastic must be an essential good with no substitutes. Here, even if there is any change in the price, the quantity demanded does not respond to it. The demand curve lies parallel to the price axis. The coefficient of elasticity is zero. Price GBP 20 Quantity Demanded 100 40 100 ππΈπ· = ππΈπ· = Inelastic demand If the percentage change in quantity is less than this percentage in price, it is inelastic demand. The coefficient of elasticity is less than one Price GBP 20 Quantity Demanded 110 40 100 ππΈπ· = ππΈπ· = ππ€ππππππ‘πππ πβππππ ππ ππ’πππ‘ππ‘π¦ πππππππ‘πππ πβππππ ππ πππππ 10 = −0.2 50 πππππππ‘πππ πβππππ ππ ππ’πππ‘ππ‘π¦ πππππππ‘πππ πβππππ ππ πππππ 0 =0 100 Unitary elastic demand If the percentage change in quantity and percentage change in price is equal to each other, price elasticity is unitary. coefficient of elasticity is 1 and the shape of the demand curve is same as a rectangular hyperbola. Price GBP 20 Quantity Demanded 100 40 200 ππΈπ· = ππΈπ· = πππππππ‘πππ πβππππ ππ ππ’πππ‘ππ‘π¦ πππππππ‘πππ πβππππ ππ πππππ 100 = −1 100 Perfectly Elastic Demand Here there is a change in quantity without any change in price. Here there is a change in quantity without any change in price. The coefficient of elasticity is infinity. Elastic Demand If the percentage change in quantity is greater than the percentage change in price, it is called elastic demand. The coefficient of elasticity is greater than one Price GBP 20 Quantity Demanded 100 30 25 ππΈπ· = ππΈπ· = πππππππ‘πππ πβππππ ππ ππ’πππ‘ππ‘π¦ πππππππ‘πππ πβππππ ππ πππππ 75 = −1.5 50 Price GBP 20 Quantity Demanded 100 20 200 ππΈπ· = ππΈπ· = πππππππ‘πππ πβππππ ππ ππ’πππ‘ππ‘π¦ πππππππ‘πππ πβππππ ππ πππππ 100 =∝ 0 Determinants of Price elasticity of demand. ο· Whether the concerned good is essential or luxury. Consumers cannot withdraw from consumption in response to price changes in essential goods. But the situation is different when it comes to luxury goods. Accordingly, the prices of essential goods are on the inelastic side and the prices of luxury goods are on the elastic side. ο· Number of substitutes available. Goods that are highly substitutable have inelastic demand and goods that are scarcely substitutable have inelastic demand. ο· Amount to be sacrificed from consumer income When the amount to be devoted to purchasing the product increases, it moves towards inelasticity. When the amount sacrificed is less, elasticity moves towards the elasticity side ο· Alternative users of goods Demand for a good is inelastic when there are many alternative uses for a good. And it became an elastic demand when there are fewer alternatives. The practical importance of Price elasticity of demand. ο· ο· ο· ο· When making economic decisions When compiling economic policies When making a production decision. When imposing an indirect tax. Change in quantity demanded and Change in demand. The change in quantity demanded represents the change in quantity demanded in response to a change in the price factor. Here all factors except price remain constant. This is also called moving upward and downward along the demand curve. A decrease in quantity demanded relative to an increase in price is called an upward movement along the demand curve, and an increase in quantity demanded relative to an increase in price is called a downward movement along the demand curve. change in demand is the change in demand relative to a change in any factor except price among the factors that determine demand. Here the demand curve shifts leftward or rightward. A decrease in demand is represented by a shift to the left and an increase in demand is represented by a shift to the right. ο· ο· ο· The following factors influence the demand curve to shift to the left ο· ο· ο· ο· According to the above graph, it appears that the price remains constant at 20 while the demand curve is shifted to the left by 50 units. Similarly, the quantity demanded has increased by 50 units when the demand curve is shifted to the right. You must understand that in both cases the price remains fixed at 20. The following factors influence the demand curve to shift to the left ο· ο· Decrease the price of substitute goods. Increase the price of complementary goods. Declining consumer income Expect that the price will decrease in future Decreasing the number of customers. ο· ο· Increase the price of a substitute good. Decrease the price of complementary goods. Increase consumer income. Increase consumer taste. Expect that the price of the good will increase in the future. Increase the number of customers Now that we have properly understood the change in quantity demanded and change in demand, we can discuss other concepts of elasticity. Cross Elasticity of demand Cross elasticity of demand is the response of quantity demanded of desired goods to change in the price of a related good. In crosselasticity of demand, it assumes all other factors that determine demand remain constant except the price of the related good. It can be calculated by following the formulas. goods, inferior goods, luxury goods, etc. ππΈπ· πΆπΈπ· πππππππ‘πππ πβππππ ππ ππππππ ππ πππ ππππ πΊπππ = πππππππ‘πππ πβππππ ππ πππππ ππ πππππ‘ππ πΊπππ = πππππππ‘πππ πβππππ ππ ππππππ πππππππ‘πππ πβππππ ππ πΆπππ π’πππ ππππππ ππΈπ· = πΆπΈπ·π₯ = βππ·π₯ ππ¦ × βππ¦ ππ₯ βππ· π × βπ ππ· ππΈπ· = πΌπππππ ππππ π‘ππππ‘π¦ ππ ππππππ πΆπΈπ·π₯ = πΆπππ π ππππ π‘ππππ‘π¦ ππππππ βππ· = πΆβππππ ππ ππ’πππ‘ππ‘π¦ ππππππππ βππ₯ = πΆβππππ ππ ππ’πππ‘ππ‘π¦ ππ ππππ π₯ βπ = πΆβππππ ππ ππππ π’πππ ππππππ βππ¦ = πΆβππππ ππ πππππ ππ ππππ π¦ π = πΌπππππ ππ₯ = πππππ ππ ππππ π ππ· = ππ’πππ‘ππ‘π¦ ππππππππ ππ₯ = ππ’πππ‘ππ‘π¦ ππ ππππ π₯ Co-efficient of income elasticity of demand is positive for normal goods Here, if the coefficient of crosselasticity of demand is positive, then it is a substitute good. it is a complementary good if it has a negative valuey good. Practical Importance of Cross elasticity of demand. ο· ο· ο· ο· Analyze the inter-relationship between goods. Understanding the market competition of a good. Classification of goods. Preparation of Pricing policy Income elasticity of demand (YED) The income elasticity of demand is how demand responds to changes in consumer income. The income elasticity of demand is recorded differently for each type of good. This elasticity varies as essential The coefficient of income elasticity of demand is positive and greater than one for luxury goods. The coefficient of income elasticity of demand is positive and less than one for essential goods. The coefficient of income elasticity of demand is negative for inferior goods. Practical experience of Income elasticity of demand. ο· ο· ο· Importance of production planning Helpful in business research Helpful to understand the buying behavior of consumers.
