11-08-2020

Demand & Supply

Demand

1. Desire (to have a commodity / product)

backed by purchasing power and

willingness to pay.

2. Demand refers to the amount of

the good that buyers are willing
and able to purchase ( Mankiw)

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Law of Demand

There is an inverse relationship

between the price of a good and
the quantity of the good
demanded per time period, other
things being held constant.

Substitution Effect
Income Effect

Individual Consumer’s Demand

function: QdX = f(PX, I, PY, T)
QdX = quantity demanded of commodity X
by an individual per time period
PX = price per unit of commodity X
I = consumer’s income
PY = price of related (substitute or
complementary) commodity
T = tastes of the consumer

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+/- +/- +/-

QdX = f(PX, I, PY, T )

QdX/PX < 0+
QdX/I > 0 if a good is normal
QdX/I < 0 if a good is inferior
QdX/PY > 0 if X and Y are substitutes
QdX/PY < 0 if X and Y are complements

Market Demand Curve

Horizontal summation of
demand curves of
individual consumers

• Bandwagon Effect
• Snob Effect

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Horizontal Summation: From

Individual to Market Demand

Market Demand Function

QDX = f(PX, N, I, PY, T)
QDX = quantity demanded of commodity X
PX = price per unit of commodity X
N = number of consumers on the market
I = consumer income
PY = price of related (substitute or
complementary) commodity
T = consumer tastes

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Demand Faced by a Firm

• Market Structure
– Monopoly
– Oligopoly
– Monopolistic Competition
– Perfect Competition
• Type of Good
– Durable Goods
– Nondurable Goods
– Producers’ Goods - Derived Demand

Linear Demand Function

QX = a0 + a1PX + a2N + a3I + a4PY + a5T

PX Intercept:
a0 + a2N + a3I + a4PY + a5T

Slope:
QX/PX = a1

QX
Eg. Qx =100-5Px

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Price Elasticity of Demand

Q / Q Q P
Point Definition EP   
P / P P Q

P
Linear Function EP  a1 
Q

If Qx =100-5Px ; a1 = ?

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6 A Ep = -∞
Q=600-100P
5
4
B
C
Price

3 F Ep =1
2
1
0
J Ep =0
0 100 200 300 400 500 600

Q / Q Q P
1. At point B: EP    = - (100/1) * (5/100)
P / P P Q
= -1(5/1) = -5

2. At point A: = -(100/1)(6/0) =-∞

3. At point J = -(100/1)(0/6) = 0

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Price Elasticity of Demand

Q2  Q1 P2  P1
Arc Definition EP  
P2  P1 Q2  Q1

 Arc Elasticity is appropriate for analyzing

the effect of discrete changes in price.
 For example, a price increase from $1 to $2
could be evaluated by computing the arc
elasticity.
 In actual practice, most elasticity
computations involve the arc method.

Example: Consider the NBA Corporation,

which had monthly shoe sales of 10000
pairs (at $ 100 per pair) before a price cut
by its major competitor. After this price
reduction by the competitor, NBA’s sales
declined to 8000 pairs a month. From the
past experience, NBA has estimated the
price elasticity of demand to be about -2.0
in this price-quantity range. If NBA wishes
to restore its sales to 10000 pairs a month,
what price that must be charged ?

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Marginal Revenue and Price

Elasticity of Demand
 1 
MR  P 1  
 EP 
TR=p x q; MR= d(pq)
--------
d(q)
dq dp
= p* --- + q* ----
dq dq
q d(p) 1
= p 1 + --- * ---- --
p d(q) Ep

Marginal Revenue and Price

Elasticity of Demand

PX
EP  1
EP  1

EP  1

QX
MRX

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Marginal Revenue, Total

Revenue, and Price Elasticity

TR MR>0 MR<0
EP  1 EP  1

QX
EP  1 MR=0

Marginal Revenue, Total Revenue, and Price Elasticity

TR MR>0 MR<0
E P  1 E P  1

E P  1 MR=0

PX QX

EP  1
EP  1

EP  1

QX
MRX

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Determinants of Price Elasticity of Demand

Demand for a commodity will be more

elastic if:
 It has many close substitutes
 It is narrowly defined
 Time Factor: More time is available to
adjust to a price change
 Nature of the product- necessities are
inelastic; luxury -> elastic, as you can
postpone demand
 Greater the Proportion of income spent on
a commodity.

Determinants of Price
Elasticity of Demand
Demand for a commodity will be less
elastic if:
It has few substitutes
It is broadly defined
Less time is available to adjust to a
price change

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Income Elasticity of Demand

Q / Q Q I
Point Definition EI   
I / I I Q

I
Linear Function EI  a3 
Q

Income Elasticity of Demand

Q2  Q1 I2  I1
Arc Definition EI  
I 2  I1 Q2  Q1

Normal Good Inferior Good

EI > 0 EI < 0

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Cross-Price Elasticity of Demand

QX / QX QX PY
Point Definition EXY   
PY / PY PY QX

Linear Function PY
E XY  a4 
QX

Cross-Price Elasticity of Demand

QX 2  QX 1 PY 2  PY1
Arc Definition EXY  
PY 2  PY 1 QX 2  QX 1

Substitutes Complements

EXY  0 EXY  0

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Other Factors Related to

Demand Theory
• International Convergence of Tastes
– Globalization of Markets
– Influence of International Preferences on
Market Demand
• Growth of Electronic Commerce
– Cost of Sales –> reduces cost of selling,
new methods of sale like auctioning etc
– Supply Chains and Logistics
– Customer Relationship Management

THE CONSTANT- ELASTICITY DEMAND FUNCTION

So far, we assumed that the demand function is linear.
That is, the quantity demanded of a product has been
assumed to be a linear function of its price, the prices of
other goods, consumer income, and other variables.
Another mathematical form that is frequently used is the
constant-elasticity demand function. If the quantity
demanded) depends only on the product's price (P) and
consumer income (I), this mathematical form is:
Q = aP-b1 Ib2 --------------- (1)

Thus, if a = 200, b1 = 0.3, and b2= 2,

Q = 200P-0.3 I2
An important property of this demand function is that the
price elasticity of demand equals b1, regardless of the value
of P or I (This accounts for its being called the constant-
elasticity demand function.)
To see this, differentiate Q with respect to Price:

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Q ----------- (2)
= - b1aP-b1-1 Ib2
P b
 b1 1* Q
= a P-b1 Ib2 = P
-------- (3)
p
Thus,  Q  
P
 = -b1
---------- (4)
P Q
Constant-elasticity demand function is often used by managers and
managerial economists, for several reasons:
First, in contrast to the linear demand function, this mathematical form
recognizes that the effect of price on quantity depends on the level of
income, and that the effect of income on quantity depends on the
level of price. Thus, multiplicative relationship in equation (1) is often
more realistic than additive relationship in linear equations.
Second, like the linear demand function, the constant-elasticity demand
function is relatively easy to estimate. If we take logarithms of both
sides of equation (1),
logQ = log a - b1 log P + b2log I
Since this equation is linear in the logarithms, the parameters- a, b1,
and b2 can readily be estimated by regression analysis.

Total Outlay(Revenue) Method of Measuring Ep

The picture can't be display ed.

Sl no Price Quantity Total Rev. Ep

(PxQ)

1. 15 200 3000
12 300 3600 Ep>1
2. 15 200 3000
12 250 3000 Ep=1
3. 15 200 3000
12 210 2520 Ep<1

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Total Outlay (Revenue) Method of Measuring Ep

Numerical on: MC, Ep,& P

In equilibrium, MC = MR.
 1 
Hence, MR = MC = P 1  Pe 
 
 
 1 
P = MC 
1 
1 

 Pe   
 1 
Now, 1) If MC =10, Pe = -2, then P =10 
1 
1 
 = 20.0
 2 
 
 1 
2) If MC =10, Pe = -5, then P =10 
1 
1 

= 12.5
 5 

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Complementarities – natural or artificial - make

good business!!
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The picture can't be display ed.

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Impact of tastes/preferences on demand: example:

Tablet sales jump over 400% while desktops stay flat
Pankaj Doval TNN 25 July, 2013

New Delhi: The new-age tablet is apparently gobbling up the PC market. Sales of tablets shot up from just 3.6 lakh
units in 2011-12 to over 19 lakh in the last fiscal, a jump of over 400%, even as desktop PC sales grew by just 1%.
The picture can't be display ed.
The picture can't be display ed.

Latest data released by the Manufacturers’ Association for Information Technology (MAIT) on Wednesday showed
the demand for tablets was driven by users’ desire for apps (applications) to track everything from calories burned
to the weather to navigating the city.
Although India was a late entrant to the world of smart phones and tablets, it now seems to be moving in line with
global trends, with users climbing up the ladder. Smartphone sales went past 1.5 crore units in 2012-13, compared
to over 95 lakh in the previous year. Desktop computer sales was at 67.69 lakh units.

BIG BITE
- 19 lakh tablets sold in 2012-13, up from just 3.6 lakh the year before, a growth of 427%
- Just 1% growth in desktop sales in 2012-13; overall PC market up 5%
- 79% of tablet-buyers owned a PC or Smartphone
- 21% were 1st-time buyers of a computing device
PSUs, govt institutions keep PCs alive But unlike the international market, where PC sales have declined for
straight quarters, institutional demand and purchases in smaller towns is keeping companies in business.
The latest International Data Corporation (IDC) numbers show that PC sales fell almost 14% in January-March
2013, while tablets surged 143% 4.9 crore units. In fact, the first quarter global tablet sales was more than what
was sold during January-June 2012, reflecting skyrocketing demand in emerging markets such as India.
With prices going down, consumers have plenty to choose from. Right from the top-notch Apple iPads that cost
around Rs 50,000 to a gamut of devices from Samsung and then percolating down to home-grown brands like
Micromax and Karbonn, tablets come for as low as Rs 5,000.
A bulk of the desktop PC sales is restricted to government, PSUs and educational establishments, which together
account for as much as 65% of the sales. “In terms of household sales, these are happening in what I would call
the ‘rest of India’, or C-class towns. The metros and B-class towns are no longer major buyers of desktops,” said
Ramamurthy, who now wants a special package from the government to “revive” the PC market. TNN

Market experiment: an example:

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The picture can't be display ed.

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Show the impact of this finding on market demand

using an appropriate diagram

Show the impact of the EU action on Market

Equilibrium using appropriate diagram

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1.Suppose the demand for wheat (measured in

quintals) is: Qw = 100000 - 500Pw ; this year’s
harvest is 80000 quintals, where Qw is quantity of
wheat and Pw is price of wheat.
a) What will be total revenue of the farmers this
year?
b) What will happen to farmer’s revenues, if next
year’s harvest were to fall below this year’s
harvest?

2. A firm has estimated the following demand function for its product:
Q = 100 − 5P + 5I + 15A; where Q is quantity demanded per month in
thousands, P is product price, I is an index of consumer income, and A
is advertising expenditures per month in thousands. Assume that
P = $200, I =150, and A = 30. Use the point formulas to complete the
elasticity calculations indicated below.

(i) Calculate quantity demanded and Price elasticity of demand.

(ii) Is demand elastic, inelastic, or unit elastic?
(iii) Calculate the income elasticity of demand. Is the good normal
or inferior? Is it a necessity or a luxury?
(iv) Calculate the advertising elasticity of demand.

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