Economics for Business

Economics for Business

Demand & quantity demanded

• "Demand" is the relationship between the price that is charged and the amount that will be bought at that price.

• Demand is not a single quantity. Rather, it is a table or graph showing some prices that might be charged and the corresponding amounts that buyers will want to buy. So "Quantity demanded" is the amount that will be bought at a particular given price.

Demand and want

• Demand indicates how much of a good consumers are willing and able to buy at each possible price during a given time period

• Willingness and ability are very important• Because demand is different from ‘want’ or

‘need’

Individual & market demand

• Individual demand refers to the demand of an individual

• Market demand is the sum of all the individual demands of all the consumer in the market

5 of 48

From HouseholdDemand to Market Demand

• Assuming there are only two households in the market, market demand is derived as follows:

Law of demand

• Quantity demanded varies inversely with price, other things remaining constant

• The higher the price, the smaller the quantity demanded

• The lower the price, the larger the quantity demanded

The other things• Money income of consumers• Prices of related goods

– Substitutes– Complements

• Consumer expectations• Number and composition of other consumers

in the market• Tastes of the consumers• Weather, population, etc

Q f P holding cons t other factorsd ( tan )

Qd

P

Demand Curve

Change in Quantity Demanded(Movement Along a Demand Curve)

A movement along a demand curve occurs when own price changes, holding constant other factors.

What are the other factors that we are holding constant?

Supply• Example of a farmer having 2 pieces of land;

valley and hillside• Either he could rear sheep or grow vegetables

or a mix of both• What if price of vegetables starts rising?• Obviously, the farmer will allocate more piece

of land to grow vegetables• A further increase in price induces him to

allocate more land to vegetable production

• When the price of a good rises, the quantity supplied will also rise and vice versa

Price determination

• Shortage and surplus• P

SURPLUS

SHORTAGE

Q

Change in demand• P

d2 sd1

0 Q

Change in supply

Identification problem• P

D2 S2 S1D1

0 Q

Shift in Demand: Population (POP)

Qd

P

With an increase in POP, the demand curve shifts to the right.

With the demand curve shifting to the right, the quantity demanded increases for all prices. £3

20 30Factors that lead consumers to change demand quantities at the same price are referred to as demand shifters.

Normal & inferior goods

• Goods can be classified in two broad categories

• Normal goods– Demand increases when income increases & vice

versa• Inferior goods

– Demand decreases when income increases & vice versa

A few commodities such as dry beans and potato are called inferior goods.

• As income increases consumers tend to buy less of the inferior goods as they can now afford more expensive normal goods.– That is, an increase in

income shifts the demand curve for an inferior good to the left.

Qd

P

$3

20 30

Elasticity

• Elasticity is a measure of responsiveness.• The most common elasticity measurement is

that of price elasticity of demand. It measures how much consumers respond to a change in price. The basic formula used to determine price elasticity is

• e= (percentage change in quantity) / (percentage change in price).

Elasticity – the concept

• The responsiveness of one variable to changes in another

• When price rises, what happens to demand?

• Demand falls• BUT!• How much does demand fall?

P

Qd

P

Qd

The flatter the demand curve, the more price elastic is the demand.

flatter steeper

The flatter the demand curve, the more room there is for the quantity to adjustment.

Hence, the flatter the demand curve, the more responsive is the quantity to a price change.

Own price elasticity

• Response of quantity demanded to a change in its own price is termed as own price elasticity

Cross price elasticity

The Cross-Price Elasticity of Demand measures the rate of response of quantity demanded of one good, due to a price change of another good. If two goods are substitutes, we should expect to see consumers purchase more of one good when the price of its substitute increases. Similarly if the two goods are complements, we should see a price rise in one good cause the demand for both goods to fall.

ElasticityPrice

Quantity Demanded (000s)

D

The importance of elasticity is the information it provides on the effect on total revenue of changes in price.

£5

100

Total revenue is price x quantity sold. In this example, TR = £5 x 100,000 = £500,000.This value is represented by the grey shaded rectangle.

Total Revenue

ElasticityPrice

Quantity Demanded (000s)

D

If the firm decides to decrease price to (say) £3, the degree of price elasticity of the demand curve would determine the extent of the increase in demand and the change therefore in total revenue.£5

100

£3

140

Total Revenue

ElasticityPrice (£)

Quantity Demanded

10

D

5

5

6

% Δ Price = -50%% Δ Quantity Demanded = +20%Ped = -0.4 (Inelastic)Total Revenue would fall

Producer decides to lower price to attract sales

Not a good move!

ElasticityPrice (£)

Quantity Demanded

D

10

5 20

Producer decides to reduce price to increase sales

7

% Δ in Price = - 30%% Δ in Demand = + 300%

Ped = - 10 (Elastic)Total Revenue rises

Good Move!

Giffen good

• A Giffen good is an extreme type of inferior good. The negative income effect of changes in price of a giffen good is stronger than the substitution effect. This leads to its special quality: “when the price of a giffen good rises, consumers actually buy more of it.”