DEMAND ANALYSIS:

The individual demand curve

The schedule below shows the quantity demanded of a commodity by an individual at different
price level
Price of Quantity Demanded
Good X of Good X
(Price per unit) (units per week)
10 3
20 2
30 1
40 0
Plotting the above information on a graph results in the individual demand curve
40 D

30 Individual Demand curve: relates the quantity demanded

Price ($) of a product by an individual at a specific price during a
particular
20 period

10

0 1 2 3 4D (units X)
Quantity Demanded
Demand: The quantity of a good or service an individual is willing and able to purchase at a given price
during a specific period.
Factors influencing the demand for a product
THE demand Function

Dx = Ꞙ (Px, Pr, Y, T, E. A, Z)
Where:

Px: the price of Good X

Pr: the price of related goods (substitute or compliment)

Y: consumers income

T: consumer’s taste and preference towards Good X

E: expectation of price changes in the future

A: Advertisement of Good X

Z: all others (natural disaster, climatic and weather conditions, government policies, population changes
etc)

Market Demand

A market is the area where buyer and sellers meet to Trade. Thus, there is a market for every good or
service;

Market Demand is the sum total of all the individuals in a market for a particular product

price 5 price 5 5 = price 5

4 q/d 8 q/d 12 q/d 24 q/d

Law of Demand
States that as the price of a commodity rises the quantity demanded falls and as the price
decreases the quantity demanded increases., resulting in a downward (negative /inverse)
sloping demand curve from left to right.

A Normal Good is one that follows the Law of Demand

PRICE

Dx = Ꞙ(Px)
D

An inferior Good is one that goes contrary to the law of Demand.

There are two type of inferior goods Giffen goods and Veblen good.

D
PRICE

QUANTITY DEMANDED

Law of Demand from the Point of View of INCOME

Dx = Ꞙ(Y)
As income rises the quantity Demanded also increases and as income decreases
the quantity demanded also falls
With respect to income a Normal good follows the law of Demand and is
represented by an upward sloping demand curve from left to right, illustrating
in a positive relationship between income and quantity demanded.
As shown in figure … above.

An inferior Good behaves opposite to the law of demand with respect to

Income
A Giffen Good: an extreme inferior good of the
Lower class
INCOME (Y)

D
Quantity Demanded

Elasticity of Demand

Definitions:
Elasticity An economic model/tool used to measure the level of responsiveness of
a change in one economic variable brought about by changes in another
economic variable. In other words, its used to measure the strength of
relationship between economic variables.
Elasticity of Demand is a measure of the responsiveness of a change in the
quantity demanded of a commodity brought about by changes in another
economic variable; mainly: the
(1) PRICE of the commodity: PRICE ELASTICITY OF DEMAND
(2) INCOME of the consumer: INCOME ELASTICITY OF DEMAND
(3) PRICE of RELATED goods: CROSS ELASTICITY OF DEMAND
PRICE ELASTICITY OF DEMAND:
Is a measure, of the responsiveness of a change in the quantity demanded
brought about by a change in Price

Formula:
PED = - (proportionate change in the quantity Demanded) / (proportionate
change in the price), or
PED = - (% Qx / % PX;
Where: % Qx = ((Q0 – Q1) / Q0 ) X 100;
And: % PX = ((P0 – P1) / P0) X 100
∞The resulting figure/quotient can be interpreted in several ways:

(1) Relative Elastic: 1< PED < ∞

(2) Relatively Inelastic: PED < 1
(3) Unitary Elastic: PED = 1
(4) Perfectly Elastic: PED + infinity
(5) Perfectly Inelastic
Price Elasticities of Demand
Interpretation and Graphical expression:
(1) Relatively Elastic: means for any change in the PRICE the quantity
Demanded changes more than proportionate. In other words, what ever
the change in price once the situation is ELASTIC the change in in price
should generate a greater change in the quantity demanded. Whether it
may be an increase or decrease in price. STRONG RESPONSE

P1

P2
Price
D
Q1 Q2
QUANTITY DEMANDED
For a small change in price There is a GREATER change in the quantity
Demanded resulting in GENTLE/GRADUAL sloping DEMAND CURVE

(2) Relative Inelastic: means for any change in the PRICE the quantity
Demanded changes less than proportionate. In other words, whatever the
change in price once the situation is INELASTIC the change in in price will
be greater . Whether it may be an increase or decrease in price. WEAK
RESPONSE

P1 For a GREAT change in Price the

Quantity Demanded is LESS resulting in
A STEEP sloping Demand Curve
P2

PRICE

D
 Q1 Q2 Quantity
(3) Unitary Elastic: means for any change in the PRICE changes in the quantity
Demanded is equally proportionate. Whenever the price changes the
change in the quantity demanded is the same. NEUTRAL

P1 B

PRICE

P2 C D

0
Q1 Q2
QUANTITY
In the diagram above the percentage change in the quantity demanded is
equally responsive to the percentage change in price. As a result Total
Revenue will remain unchanged. Thus, the rectangle OP1B Q1 must equal
the rectangle OP2CQ2

(4) Perfectly Elastic: Means that at a constant price the quantity demanded
Changes infinitely

At a CONSTANT price Quantity Demanded

Is Infinite
PRICE D

QUANTITY
 (5) Perfectly Inelastic: Means that for infinite changes in the price the quantity
demanded remains constant
D
INFINITE
PRICE

Constant Quantity

INCOME ELASTICITY OF DEMAND

Is a measure, of the responsiveness of a change in the quantity demanded
brought about by a change in income of the consumer

Formula:
YED = (proportionate change in the quantity Demanded) / (proportionate
change in the income of the consumer), or

YED = % QX / % Y
NB: The Interpretation and calculation are the same as the Price Elasticity
explained above substituting the word Income for Price.
The relationship however, between the consumers income and the quantity
demanded of the commodity, is Direct/Positive.
Relative Elastic: means for any change in the income of the consumer the
quantity demanded for the good changes more than proportionate
$
y1 D
y2

Q1 Q2
For a small change in consumers income there is a greater change of the quantity
Demanded. This results in a gentle/gradual upward sloping curve from left to
right. Strong Relationship

Relatively Inelastic: Means for any change in consumers income there is a lesser
change in the quantity demanded
D
Y2 for a great change in Income there is lesser
INCOME in the quantity Demanded. WEAK relationship
Y1

Q1 Q2 Quantity

CROSS ELASTICITY OF DEMAND

A measure of the responsiveness of a change in the Quantity Demanded as a
result of changes in the PRICE of a Related goods which can either be a
SUBSTITUTE or a COMPLIMENT:
Xed = (Proportionate change of Quantity Demanded) / (Proportionate change in
the price of related good.)
Xed = % QDX /% PR
NB: Same RULES and INTERPRETATION as the other Elasticities explained above.
Graphical expressions:
COMPLIMENT: SUBSTITUTE

D
PRICE OF PRICE OF
Compliment SUBSTITUTE

Quantity Demanded of X
Arc Elasticity of Demand:

Point Elasticity of Demand:

Price Elasticity of Demand: Is very important in Formulating/implementing

Pricing Policies/Strategies in a business.
It is very important for the decision makers of businesses to understand the
ELASTICITY of the products that is being sold, so that the correct pricing strategy
can be adopted in as much as Total Revenue of the business is directly affected by
the same. What therefore is the relationship between the Price elasticity of
Demand and Total Revenue? The diagram below shows such relationship.

A
PRICE PED >1
!
PED = 1

PED < 1

QUANTITY
B

Total
Revenue Total Revenue = Q x P
TR

QUANTITY
Diagram A above shows that as prices decrease in area of elasticity i.e. where PED
is greater than 1 the Total Revenue shown in diagram B below rises. At PED = 1
total revenue remains constant. However, if price continue to decrease in areas of
Inelasticity the Total Revenue also decreases. Sale manager should therefore
conclude the following:
That for goods which have an
(1) Elastic price elasticity of demand: Decision - Decrease prices. As this would
cause a greater change in the quantity demanded thus causing Total
Revenue to increase;

(2) Inelastic Price Elasticity of Demand: Decision – increase Prices: The

quantity demanded would not be greatly affected due to the weak
relationship between both variables. Total revenue will rise mainly through
the increased prices.

Theory of Demand:
Two different Schools of thought:
(1) The Cardinalist: Marginal Utility Theory and “The Law of Diminishing
Marginal Utility”;
(2) The Ordinalist’: Indifference curve analysis.

Cardinalists
The Cardinalists promote the idea that satisfaction can be measured in cardinal
number which means satisfaction can be quantified and expressed as any whole
number 5 utils, 18 utils, 200 utils. Thus, the term utils is used to express the unit
off measure for the satisfaction one derives from the consumption of a good or
service.
Each unit of a good gives a specific amount of utils which is the Total Utility of that
particular unit, however as one consumes additional units of a good the
extra/marginal satisfaction/Utility derive decreases. This gives rise to the term
“The Law of Diminishing Marginal Utility”

Definitions:
Utility: the level of satisfaction an individual derives from the consumption a good
or service
Utils: the unit measurement for the amount of satisfaction an individual derives
from the consumption.
Total Utility: the amount of utils one derives from the consumption of one one of
a good or service:
Example: Imagine what five bottles of water does for a runner after a long-
distance race in tropical conditions. Rank each bottle of water with respect to the
individual’s satisfaction. The table below indicates the utils derive from each
bottle of water.
Bottles of water Total utility Marginal utility
0 0 0
1 10 10-
2 14 4
3 16 2
4 17 1
5 17 0
6 15 -2
7 14 -3

Graphically expressing the above data, the Total Utility Curve can be plotted;
 17 1 0
16 2 * 2
14 4 * 1
Total 10 *
utility TR

1 2 3 4 5 6 7 Quantity
A Simplified TR curve

Total TR
Utility

Quantity consumed
Analyzing the graphs above one would noticed that in relation to the Total utility
of each unit consumed the addition satisfaction gained decreases until a level of
DISUTILITY is observed i.e. when the Marginal utility derived from an extra unit
consumed becomes negative. A rational consumer should actually stop
consumption when there no more utility to be gained.

Marginal Utility: extra utility/satisfaction gained from the consumption of one

additional unit of a good or service:
Plotting the Marginal Utility Curve:
 10

mu
4
2
0 1 2 3 4 5 6 7
QUANTITY MU

Marginal
Utility
MUx

Quantity consumed
The Law of Diminishing Marginal Utility states that as one consumes additional
units of a good the Marginal Utility decreases:

Derivation of the Individual Demand Curve:

Because of the law of diminishing marginal utility a rational consumer would only
buy an extra unit of a good or service if the PRICE of the commodity falls, in as
much as, the utility gain from its consumption decreases. Thus, as the price a
good decrease more is consumed to the point where the marginal utility derived
is equal to the last cent/penny spent: Mux = Px. Known as consumers
Equilibrium/maximization/Optimization.

10
marginal
Utility 4
2
1
-2
$ - -3

Price P1
P2
P3

P4
1 2 3 4 5 Quantity Demanded
Dx
Figure: ! above shows that as an extra unit is consumed the marginal utility of
each decreases this the basis for the formation of the demand curve; Downward
Sloping from Left to Right which explains the fact that as price decreases the
quantity demanded increases. This only happens because the consumer will only
purchase an extra unit of a good when the price of the sane falls. This so because
the marginal utility or extra satisfaction gain will decrease.
The consumer will therefore consume to the point where the marginal utility is
equal to zero
Consumer’s Equilibrium therefore occurs when the consumer marginal utility is
equal to the last cent/penny

Consumer’s Equilibrium for one good

MUX = Px

Consumer Equilibrium for two goods X and Y:

The marginal Utility per cent/penny RATIO

Mux / Px = MUy/ Py
OR
The Marginal Utility Equation Condition

Mux/MUy =Px/Py

Given the following schedule determine the quantity of both goods

the individual must consume to achieve consumer’s equilibrium?
Price per Hot dog: $10.00
Price per Hamburger: $20.00:
Quantity Total Total Marginal Marginal MU Ratio MU Ratio
consumed Utility Utilty Utility Utiliy Mux/Px MUy/Py
(units) Hot dog Hamburger Hot dogs Hamburger
0 0 0
1 250 250
2 450 200
3 640 190
4 790 150
5 900 110

The Ordinalists:
The Ordinalists use what is known a Indifference Curve Analysis to explain
consumer equilibrium point. The indifference curve is based on the consumers
being able to rank their preference; in an orderly manner; i.e. 1 st, 2nd, 3rd among a
specific category of goods and services.
Indifference Curve : A curve which shows all the combinations of two goods that
yield equal satisfaction/Utility to the consumer. This means the consumer is
indifferent about any combination/point along the curve:

X
Goody X
X
X Indifference curve(MRS)

Good x
Thus. the indifference curve is intended to illustrate the behavior/characteristics
of a Rational consumer: A rational consumer must be able to:
(1) rank his or her preferences among a field of choices;
(2) be Transitive which means one must be clear about such preferences
and not confused,
(3) not want all of one good but must want more or less, at least some of
the other

Characteristics of an Indifference Curve.:

(1) Existence of an Indifference Curve MAP which represents the consumer
field of choices. Higher the indifference curve greater is the preference for
the product. Figure 1ID below illustrates the same.

GOOD Y
 ID4 Indifference
ID3 Curve
ID2 Map showing
ID1 Field of Choices

GOOD X
(2) Indifference curve never intersect which must reflect the decisiveness and
clarity of the consumer about such preferences. I Assuming Good A is
preferred to Good B and Good B is preferred to Good C Then Good C can
never be preferred to Good A. The diagram below depicts such a scenario:

A
GOOD Y B
C

GOOD X
Combination A should not be on the sane indifference curve with combination C
as A is Preferred to C.
(3) Indifference Curve slopes downward from left to right which indicates in
that in order to have more units of Good X, units of Good Y must be given
up. The indifference curve there reflects the consumers Marginal Rate of
Substitution MRS which the rate at which the consumer substitute one
good for another
(4) Indifference Curves are Convex at the origin: the indifference curve should
not touch any of the axis in as much as the consumer must not want all of
one good must at least want some of the other.
 GOOD Y

GOOD X
Budget Line: This shows the combination of two goods that can be purchased
with a given Income
Example: Given an income of $100 to be spent between two goods X and Y
Price of Good X: $5.00
Price of Good Y: $10.00
Draw a Budget Line to show the same.

Solution:
Spending the Total income on Good X the consumer can purchase 20 units
Spending the Total income on Good Y the consumer can purchase 10 units
Those two amounts constitute the absolute value of both Axis
 10

GOOD Y

GOO X 20
The two main factors controlling the Budget Line are:
(1) The Price of The Good
(2) The consumer’s income

Consumers Equilibrium /Maximization/Optimization Occurs whenever the

Indifference cure is TANGENT to the Budget Line

GooD Y
ID

GooD X

Consumer Equilibrium/maximization occurs when:

PX/Py = Y/ X (the indifference curve is tangent to the Budget Line)
Where: Y/ X = the slope of the curve

Shifts and Rotation of the Budget Line:

A SHIFT of the budget line occurs whenever there are simultaneous changes in
the prices of both goods and in the consumers income.
A Right or Outward shift occurs for an increase in consumer’s income or a
simultaneous fall in the prices of both goods
B2
Good Y
B1

B1 B2
A Left or Inward Shift occurs on a simultaneous increase in the prices of both
goods or for a FALL in the consumer’s income.

B1
Good Y
B2

Good X B2 B!

Rotation of The Budget Line:

This occurs when the PRICE changes in one good only
(1) A Fall in the price of Good X
B1
This causes an anticlockwise
 Rotation along the Y axis
Good Y

Good X B1 B2

(2) An increase in the Price of Good X:

B1
This causes a clockwise Rotation
Good Y along the Y axis

Good X B2 B1
(3) An increase in the price of Y
B1
Good Y This cause an anticlockwise Rotation
B2 along the X axis

B1
(4) A Fall in the Price of Good Y

B2
Good Y Clockwise Rotation along the x axis
B1
 Good X B1

Consumption Path
:Aa graphical representation of the historical pattern of the consumption of a
consumer for two goods

B3
B2 Consumption Path
I3
B3 I2
I1

Good X B1 B2 B#