Demand Analysis Unit II

7/28/2019 Demand Analysis Unit II

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Unit II


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Introduction The analysis of market demand, business executives can know

i) The factors which determine the size of demand

ii) Elasticity of demand

iii) Possibilities of sales promotion through manipulation of prices

iv) Optimum level of sales, inventories and advertisement cost


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Analysis of Market demand Meaning of Market Demand

Market Demand is the sum of individual demands for a product at a price per unit of

time. Also the quantity demanded of the commodity by an individual per unit of

time, at a given price is known as individual demand for the commodity.

The aggregate of individual demands for a product is known as market demand for

that product.

Let us consider demand curves showing the relationship between price and quantity

demanded.Consumer 1s demand curve is shown by D1D1and consumer 2s demand is shown

by D2D2. At price $15, the individual quantities demanded are 5 and 8 units. At price

$20, the individual quantities demanded are 4units and 2units. Hence, the total

demand is shown as DmDm


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Market Demand curve

2015

4 5

D1

D1

+2015

2 8

D2

D2

=

6 13

2015

0 0

0

Dm

Dm

Quantity

per period

Quantity

per period

Quantityer eriod

Price per unit Price per unit

Price per unit

Marketdemand


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Determinants of Market DemandPrice being one of the determinants of demand, is not the only factor affecting it.

The other factors are:

Price of the Product Price of the related Goods

Consumer preferences

Income


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Price Of The Product

The price of the product and its quantity demanded are inversely proportional to one

another. The law of demand states that the quantity demanded of a product which itsconsumers would like to buy per unit of time, increases when its price falls and

decreases when its price increases, other factors remaining constant.


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Price of the Related Goods The demand for a commodity is also affected by the changes in the price of its

related goods. Related goods may be Substitutes or complementary goods.

SubstitutesPrice perunit

Quantity

D

D

D

D


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Contd.. Complements

Price per

unit

Quantity

D

D

D

D


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Consumers Income Essential Consumer Goods

Inferior goods

Normal goods

Luxury goods


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Income and Substitution Effects of

a Price Change The effect of a price change on the demand for a good can be decomposed into two

effects

The substitution effect is the effect of the change in relative prices keeping real

income (utility) constant

The income effect is the effect on real purchasing power of the price change


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a Price ChangeQy

QxQx Qxs Qx

Sub Inc

ab

s

Overall effect (a to b) can bebroken down into a substitution

and income effect


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a Price Change Income effects of a price change are usually small--unless the good accounts for a

high proportion of expenditure

For normal goods the income effect works to reinforce substitution effect and a price

decline mustincrease quantity demanded

For inferior goods the income effect works against the substitution effect, but the

substitution effect is usually larger


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a Price Change What does it take to get an upward sloping demand curve? The Giffen good case

Giffen goods must be both inferior and important in the budget

Very unlikely to come across a Giffen good

Policy uses of income and substitution effects--carbon taxes and income tax rebates


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Elasticity of Demand Elasticity of Demand is defined as the degree of responsiveness of demand to the

change in its determinants.

The firm can decide to change price even without changing the cost of production or

raise the price following the rise in cost depends upon:

Price-elasticity of demand for the product, that is how high or low is the proportionate

change in its demand in response to a certain percentage change in its price


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Elasticity the concept The responsiveness of one variable to changes in

another

When price rises, what happensto demand?

Demand falls

BUT!

How much does demand fall?


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Elasticity4 basic types used:

Price elasticity of demand

Price elasticity of supply Income elasticity of demand

Cross elasticity


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Elasticity Price Elasticity of Demand

The responsiveness of demandto changes in price

Where % change in demandis greater than % change in price elastic

Where % change in demand is less than % change inprice - inelastic


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Qualitative Forecasting Models Opinion Poll Methods

(a) Expert opinion method

The firms cater the expert opinions about demand of product inmarket by their sales representatives, who are in close touch with the consumers.

The firm not having such facility, gather information about demand of their

products through the professional markets.


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Contd.. Delphi method

Iterative group process allows experts to make forecasts

Participants:

decision makers: 5 -10 experts who make the forecast

staff personnel: assist by preparing, distributing, collecting, and summarizing

a series of questionnaires and survey results

respondents: group with valued judgments who provide input to decision

makers


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Contd.. Market Studies and Experiments

The information regarding demand is collected by carrying out market

studies and experiments on consumers behavior under actual, controlled,

market conditions.

The representative markets are selected on the basis of population, income

level, cultural and social background.

Then market experiments are carried out by changing price, controlled

variables under the assumptions that other things remain constant.


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Quantitative Methods Trend Projection Method

Barometric Method

Econometric Method


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Production and Cost Productionconcepts examine the amount of input(s) needed to produce a given

output.

Costconcepts examine the cost of the inputs needed to produce a given output.

Thus cost concepts combine production concepts with input prices.


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Production function It is the tool of analysis used to explain the input-output relationship.

It describers the technological relationship between inputs and outputs in physical

terms.

The production function includes various forms of input: (i) Land (ii) Labor (iii)

capital (iv) raw material (v) time and (vi) technology

The long run production function is expressed as

Q=f(Ld, L, K, m, T, t), which is now expressed as

Q=f(K,L)


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Contd.. Short run production function

Shortrun production is also known as single variable production function, can be

expressed as:

Q=f(L)

Long-run production function, both K and L are used and function is expressed as:

Q=f(K,L)


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Short-Run Cost Measures

Fixed cost (F): production expense that does not vary with output.

Variable cost (VC): production expense that changes with quantity of output

produced.

Total cost (C): is the total expenditure incurred on the production of goods and

services.

C = VC + F

Average cost (AC): it is not the actual cost. It is obtained by dividing the total cost

(TC) by total output (Q),AC=TC/Q

Marginal cost (MC): It is defined as the cost of one additional unit of product

produced.

MC=TC/Q


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Sunk Cost We usually assume fixed cost is sunk, i.e., expenditure that cannot be recovered.

The opportunity cost of capital is zero

because you can't get this expenditure back no matter what you do.

So ignore it when making decisions

Example: walk out of a bad movie early, regardless of what you paid to attend

Otherwise, fixed cost is called avoidable.


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Cost Curve Short-Run cost-output relations

The short run TC is composed of two major elements : (i) Total Fixed Cost (TFC)

(ii) Total variable Cost (TVC)

TC=TFC+TVC

For a given quantity of output (Q), the average total cost (AC), average fixed cost

(AFC) and average variable cost (AVC) can be given as:

AC=TC/Q=TFC+TVC/Q

AFC=TFC/Q

AVC=TVC/Qand AC=AFC+AVC

Marginal cost is given as:

MC=TC/Q or first derivative of cost function, TC/Q


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Short-Run Cost Functions and Cost

Curves Linear Cost Function

TC=a + bQ

Where TC=Total Cost, Q=quantity produced, a=TFC and bQ=TVC

Given the cost function AC and MC can be obtained as follows:

AC=TC/Q=a + bQ/Q=a/Q + b

MC=TC/Q=bTC

TFC=aTFC

TVC

Output

Cos

t


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Long-Run Cost-Output Relations Long-Run is the period in which all the inputs become variable.

The variability of inputs is based on the assumption that in long run supply of all the

inputs, including those held constant in short-run becomes elastic.

Therefore, the firms expand the scale of their production by hiring a larger quantity

of all the inputs.


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Average cost, $

a

b

10

0

12

Figure 7.9 Long-Run Average Cost as the Envelope ofShort-Run Average Cost Curves

qq

d

SRACSRAC

SRAC

SRACLRAC

c

1

23

3

q , Output per day

e

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Demand Analysis Unit II