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Managerial economics -demand theory

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  • 1. Demand Theory and Its Implications In Managerial Economics Group Members Anam Arif MB-12-03 Omer Shahzad MB-12-08
  • 2. Demand is the basis of all productive activities. Demand theory is an economic theory that concerns the relationship between the demand for goods and their prices; it forms the core of microeconomics. The generation of demand can be pictorically shown as below, NEED WANT DEMAND
  • 3. Concept of Effective Demand Want Demand
  • 4. Consumer Demand Theory Individual Consumer’s Demand 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
  • 5. Consumer Demand Theory Goods Inferior Goods A good that decreases in demand when consumer income rises. Normal Goods Goods for which demand increases when income increases, and falls when income decreases but price remains constant. Substitutes A product or service that satisfies the need of a consumer that another product or service fulfills.
  • 6. Individual Demand Curve Price of a Commodity (PX) Quantity Demanded (QdX) $2 1 $1 3 $0.50 4.5
  • 7. Law of Demand The law of demand states that the quantity demanded and the price of a commodity are inversely related, other things remaining constant. If the income of the consumer, prices of the related goods, and preferences of the consumer remain unchanged, then the change in quantity of good demanded by the consumer will be negatively correlated to the change in the price of the good.
  • 8. Law of Demand There is an inverse relationship between the price of a good and the quantity of the good demanded per time period. Substitution Effect Income Effect
  • 9. Law of Demand Income Effect When price of a commodity falls then the individual can purchase more units of that commodity, thus quantity demanded for that commodity increases. Substitution Effect When price of a commodity falls, the quantity demanded for that product increases because the individual substitutes in consumption the product with its substitutes.
  • 10. Market Demand Curve Horizontal summation of demand curves of individual consumers
  • 11. Individual to Market Demand
  • 12. 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 = T Price of related (substitute or complementary) commodity = Consumer tastes
  • 13. Individual to Market Demand Bandwagon Effect People tend to purchase a commodity which others are using or in order to follow the fashion. Snob Effect Situation where the demand for a product by a high income segment varies inversely with its demand by the lower income segment.
  • 14. Demand Faced by a Firm Market Structure Monopoly Perfect Competition Oligopoly Monopolistic Competition
  • 15. Demand Faced by a Firm  Monopoly  Firm is sole producer of commodity  No substitutes  Total control on price  A rare case bound with government regulations  Examples are local telephone, electricity, public transport.  Perfect Competition  Large number of firms  Identical products  No control on price  A rare case  Examples are farmers selling wheat or rice or sugar-cane
  • 16. Demand Faced by a Firm  Oligopoly  Firms producing homogeneous or standardized products like cement  Firms producing heterogeneous or differentiated products like soft drinks  Examples are firms in production sector of the economy  Monopolistic Competition  Involves elements of monopoly and perfect competition  Firm has somehow control over price  Examples are firms in service sector like gasoline stations or barber shops
  • 17. Demand Faced by a Firm Type of Good Durable Goods Nondurable Goods Producers’ Goods - Derived Demand
  • 18. Demand Faced by a Firm  Durable Goods  Non-Durable Goods  Goods that provide services not only during the year when they are purchased but also in following years  Goods that cannot be stored and can be used within a year  Firm faces a more volatile or unstable demand  Examples are automobiles, electric appliances  Firm faces a stable demand  Examples are food, cosmetics and cleaning products
  • 19. Demand Faced by a Firm  Non-Durable Goods  Producer’s Goods  Goods that cannot be stored and can be used within a year  Goods, such as raw materials and tools, used to make consumer goods  Firm faces a stable demand  Examples are food, cosmetics and cleaning products  The demand for such goods is derived demand because it depends upon the demand for goods and services it sells  Firm’s demand for producers goods is also more volatile and unstable
  • 20. Linear Demand Function QX = a0 + a1PX + a2N + a3I + a4PY + a5T + ……. QX = Quantity demanded of commodity X faced by the firm PX = Price of commodity X I = Consumer’s income PY = Price of related (substitute or complementary) commodity T = Tastes of the consumer a = Co-efficient estimated by the regression analysis
  • 21. Price Elasticity of Demand A measure of the relationship between a change in the quantity demanded of a particular good and a change in its price. Price elasticity of demand is a term in economics often used when discussing price sensitivity. The formula for calculating price elasticity of demand is:
  • 22. Price Elasticity of Demand Price Elasticity of Demand Point Price Elasticity of Demand Arc Price Elasticity of Demand
  • 23. Price Elasticity of Demand Point Definition Linear Function Q /Q P/P EP EP a1 Q P P Q P Q
  • 24. Price Elasticity of Demand Arc Definition EP Q2 Q1 P2 P1 P2 P1 Q2 Q1
  • 25. Marginal Revenue and Price Elasticity of Demand MR P 1 1 EP
  • 26. Marginal Revenue, Total Revenue, and Price Elasticity TR MR>0 EP 1 MR<0 EP 1 QX EP 1 MR=0
  • 27. Marginal Revenue, Total Revenue, and Price Elasticity PX EP 1 EP EP 1 1 QX MRX
  • 28. Determinants of Price Elasticity of Demand Demand for a commodity will be more elastic if: It has many close substitutes It is narrowly defined More time is available to adjust to a price change
  • 29. 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