Demand Analysis


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Demand Analysis

  1. 1. <ul><li>Managerial Economics </li></ul><ul><li>Douglas - “Managerial economics is .. the application of economic principles and methodologies to the decision-making process within the firm or organization.” </li></ul>
  2. 2. <ul><li>Salvatore - “Managerial economics refers to the application of economic theory and the tools of analysis of decision science to examine how an organisation can achieve its objectives most effectively.” </li></ul>
  3. 3. <ul><li>Positive Economics:- </li></ul><ul><li>Derives useful theories with testable propositions about WHAT IS. </li></ul><ul><li>Normative Economics:- </li></ul><ul><li>Provides the basis for value judgements on economic outcomes.WHAT SHOULD BE </li></ul>
  4. 4. Scope of Managerial Economics <ul><li>Utility analysis </li></ul><ul><li>Demand and supply analysis </li></ul><ul><li>Production and cost analysis </li></ul><ul><li>Market analysis </li></ul><ul><li>Pricing </li></ul><ul><li>Investment decisions </li></ul><ul><li>Game theory </li></ul>
  5. 5. Basic problems of an economy <ul><li>What to produce( Choice) </li></ul><ul><li>How to produce ( Technology) </li></ul><ul><li>Whom to produce ( Distribution) </li></ul>
  6. 6. Fundamental Concepts Managerial Economics <ul><li>Marginal Principle </li></ul><ul><li>Opportunity cost principle </li></ul><ul><li>Incremental Principle </li></ul><ul><li>Discount Principle </li></ul><ul><li>Time Perspective </li></ul>
  7. 7. Demand Analysis <ul><li>Demand – </li></ul><ul><li>Desire + ability to pay + willingness to pay </li></ul><ul><li>Demand is relative term – </li></ul><ul><li>Price </li></ul><ul><li>Time </li></ul><ul><li>Place </li></ul>
  8. 8. Determinants of demand <ul><li>Price </li></ul><ul><li>Income </li></ul><ul><li>Taste, preference and fashion </li></ul><ul><li>Prices of related goods </li></ul><ul><li>Government policy </li></ul><ul><li>Custom and tradition </li></ul><ul><li>Advertisement </li></ul>
  9. 9. Law of demand <ul><li>If other things remain constant, when price increases demand contracts and when price decreases demand expands. Price and demand are inversely proportionate. </li></ul><ul><li>D = a - bP </li></ul>
  10. 10. Why demand curve slopes downwards <ul><li>Law of diminishing marginal utility </li></ul><ul><li>Income effect </li></ul><ul><li>Substitution effect </li></ul><ul><li>Multiplicity of uses </li></ul>
  11. 11. Market Demand Curve <ul><li>Shows the amount of a good that will be purchased at alternative prices. </li></ul><ul><li>Law of Demand </li></ul><ul><ul><li>The demand curve is downward sloping. </li></ul></ul>D Price Quantity
  12. 12. Exception to the law of demand <ul><li>Giffen Goods </li></ul><ul><li>Prestigious goods </li></ul><ul><li>Buyers illusions </li></ul><ul><li>Necessary goods </li></ul><ul><li>Brand loyalty </li></ul>
  13. 13. Elasticity <ul><li>Elasticity is a measure of responsiveness of one variable to another variable. </li></ul><ul><li>Can involve any two variables. </li></ul><ul><li>An elastic relationship is responsive. </li></ul><ul><li>An inelastic relationship is unresponsive. </li></ul>
  14. 14. Types of Elasticity of demand <ul><li>Price Elasticity of demand </li></ul><ul><li>Income elasticity of demand </li></ul><ul><li>Cross Elasticity of demand </li></ul><ul><li>Promotional Elasticity of demand </li></ul>
  15. 15. Price elasticity:  p =%  Q/%  P <ul><li>Causality: denominator numerator! </li></ul><ul><li>An elastic response is one where numerator is greater than denominator. </li></ul><ul><li> i.e., %  Q>%  P so E p  </li></ul><ul><ul><li>Imagine extreme example. </li></ul></ul><ul><li>An inelastic response is one where numerator is smaller than denominator. </li></ul><ul><li> i.e., %  Q<%  P so E p  </li></ul><ul><ul><li>Again, imagine extreme example. </li></ul></ul>
  16. 16. Look at the Extremes <ul><li>Perfectly Elastic D </li></ul><ul><li> E p  infinite </li></ul><ul><li>Perfectly Inelastic D </li></ul>P Q P Q E p  0 D D
  17. 17. Relatively Elastic vs. Inelastic Demand Curves Q 1 Q 2 Q 2 ’ P 1 P 2 D’ D D’ is relatively more elastic than D P Q
  18. 18. Point Elasticity Formula <ul><li>Point elasticity </li></ul><ul><ul><li>Point elasticity is responsiveness at a point along the demand function </li></ul></ul><ul><li>E p  Q/Q 1 </li></ul><ul><li>  P/P 1 </li></ul><ul><li>simplifying: </li></ul><ul><li>E p  Q/  P)* P 1 /Q 1 </li></ul><ul><li>Price (Rs.) </li></ul>Q Q 1 P 1 D
  19. 19. Point Elasticity Formula <ul><li>Point elasticity </li></ul><ul><ul><li>Point elasticity is responsiveness at a point along the demand function </li></ul></ul><ul><li>E p  Q/Q 1 </li></ul><ul><li>  P/P 1 </li></ul><ul><li>simplifying: </li></ul><ul><li>E p  Q/  P)* P 1 /Q 1 </li></ul><ul><li>Price (Rs.) </li></ul>Q Q 1 P 1 D
  20. 20. Example: Q=56-0.002*P <ul><li>Point elasticity </li></ul><ul><li>E p  Q/  P)* P 1 /Q 1 </li></ul><ul><li>Suppose P=17000 </li></ul><ul><li>Q=56-0.002*17000 </li></ul><ul><li>Q=56-34=22 </li></ul><ul><li>Plug into equation gives: </li></ul><ul><ul><li>E p  -0.002)* 17000 /22 </li></ul></ul><ul><ul><li>E p =-34/22=-1.54 </li></ul></ul><ul><li>Price (Rs) </li></ul>Q 22 17k D
  21. 21. Arc Elasticity Briefly, arc elasticity is simply an average elasticity along a range of the demand curve.
  22. 22. Arc Elasticity Formula <ul><li>Arc elasticity: </li></ul><ul><ul><li>Responsiveness along a range of D. function </li></ul></ul><ul><li>E p  Q/((Q 1 + Q 2 )/2) </li></ul><ul><li>  P/((P 1 + P 2 )/2) </li></ul><ul><li>simplifying: </li></ul><ul><li>E p  Q/  P)*((P 1 +P 2 )/(Q 1 +Q 2 )) </li></ul><ul><li>Price ($) </li></ul>Q Q 2 P 2 P 1 Q 1 Avg. responsiveness D
  23. 23. Example Q=56-0.002*P <ul><li>Arc elasticity </li></ul><ul><li>E p  Q/  P)*((P 1 +P 2 )/(Q 1 +Q 2 )) </li></ul><ul><li>Look at P range 16k - 17k </li></ul><ul><li>Q=56-0.002*17000 </li></ul><ul><li>Q=56-34=22 </li></ul><ul><li>Plug into equation gives: </li></ul><ul><ul><li>E p  -0.002)*(33000/46) </li></ul></ul><ul><ul><li>E p =-66/46=-1.43 </li></ul></ul><ul><li>Price ($) </li></ul>Q 22 17k D 24 16k
  24. 24. Factors influence Price elasticity of demand <ul><li>Nature of commodity </li></ul><ul><li>Availability of substitute </li></ul><ul><li>Multiplicity of uses </li></ul><ul><li>Habit </li></ul><ul><li>Proportion of income spent </li></ul><ul><li>Price range </li></ul>
  25. 25. Managerial Applications of Price elasticity of demand <ul><li>Pricing Decision </li></ul><ul><li>Fiscal policy </li></ul><ul><li>Labour market </li></ul><ul><li>International trade </li></ul>
  26. 26. Income Elasticity of Demand <ul><li>Recall demand function is: </li></ul><ul><ul><li>Q=f(P, I,P related ,Tastes,Buyers,Expectations ... ) </li></ul></ul><ul><li>Change in I causes shift in demand. </li></ul><ul><li>Size of shift depends on income elasticity. </li></ul><ul><li>E I  Q/  I </li></ul><ul><li>Focus again on point formula. </li></ul><ul><li>Value of E I determines type of good. </li></ul>
  27. 27. Values for Income Elasticity (   ) <ul><li>Sign indicates normal or inferior </li></ul><ul><li> E I  >0 implies normal good. </li></ul><ul><li>E I <0 implies inferior good. </li></ul><ul><li>Normal goods may be necessity or luxury . </li></ul><ul><ul><li>If E I >1 then this is luxury (responsive to income). </li></ul></ul><ul><ul><li>If 0<E I <1 then this is necessity (unresponsive to income). </li></ul></ul>
  28. 28. Cross Price Elasticity (E XY ) <ul><ul><li>Q X =f(P X , I,P Y ,Tastes, Buyers,Expectations ... ) </li></ul></ul><ul><li>Change in P Y causes shift in demand for X. </li></ul><ul><li>Size of shift depends on cross-price elasticity. </li></ul><ul><li>E XY  Q X /  P Y </li></ul><ul><li>Sign indicates relationship between two goods </li></ul><ul><li> E XY >0 implies goods are substitutes. </li></ul><ul><li>E XY <0 implies goods are complements. </li></ul>
  29. 29. OBJECTIVES OF SHORT TERM DEMAND FORECASTING <ul><li>Production planning </li></ul><ul><li>Evolving sales policy </li></ul><ul><li>Fixing sales targets </li></ul><ul><li>Determining price policy </li></ul><ul><li>Inventory control </li></ul><ul><li>Determining short-term financial planning </li></ul>
  31. 31. METHODS OF DEMAND FORECASTING <ul><li>Survey methods : </li></ul><ul><li>Consumer interviews </li></ul><ul><li>Opinion poll </li></ul><ul><li>Experts opinion </li></ul><ul><li>End-use method </li></ul><ul><li>Statistical methods: </li></ul><ul><li>Trend Analysis </li></ul><ul><li>Regression Analysis </li></ul>
  32. 32. Market Supply Curve <ul><li>The supply curve shows the amount of a good that will be produced at alternative prices. </li></ul><ul><li>Law of Supply </li></ul><ul><ul><li>The supply curve is upward sloping </li></ul></ul>Price Quantity S 0
  33. 33. Supply Shifters <ul><li>Input prices </li></ul><ul><li>Technology or government regulations </li></ul><ul><li>Number of firms </li></ul><ul><li>Substitutes in production </li></ul><ul><li>Taxes </li></ul><ul><li>Producer expectations </li></ul>
  34. 34. The Supply Function <ul><li>An equation representing the supply curve: </li></ul><ul><li>Q x S = f(P x , P R ,W, H,) </li></ul><ul><ul><li>Q x S = quantity supplied of good X. </li></ul></ul><ul><ul><li>P x = price of good X. </li></ul></ul><ul><ul><li>P R = price of a related good </li></ul></ul><ul><ul><li>W = price of inputs (e.g., wages) </li></ul></ul><ul><ul><li>H = other variable affecting supply </li></ul></ul>
  35. 35. Change in Quantity Supplied 20 10 B A 5 10 A to B : Increase in quantity supplied Price Quantity S 0
  36. 36. Change in Supply S 1 8 7 S 0 to S 1 : Increase in supply 6 Price Quantity S 0 5
  37. 37. Producer Surplus <ul><li>The amount producers receive in excess of the amount necessary to induce them to produce the good. </li></ul>Price Quantity S 0 Producer Surplus Q * P *
  38. 38. Market Equilibrium <ul><li>Balancing supply and demand </li></ul><ul><ul><li>Q x S = Q x d </li></ul></ul><ul><li>Steady-state </li></ul>
  39. 39. Equilibrium Price and quantity Price Quantity S D 8 7
  40. 40. If price is too low... Price Quantity S D 5 6 12 Shortage 12 - 6 = 6 6 7
  41. 41. If price is too high… Price Quantity S D 9 14 Surplus 14 - 6 = 8 6 8 8 7
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