Understanding Consumer Demand Chapter 5 Understanding Consumer Demand

The Basics of Consumer Demand Two principles of consumer behavior: Select the item that gives consumers the highest level of utility (satisfaction) The principle of diminishing marginal utility (additional satisfaction) The role of scarcity How price allocates scare resources

Factors Influencing Consumer Demand What does demand mean? What does the law of demand mean? Seven factors affecting the demand: Price of the product Price of competitors’ products (substitute products) Price of complement goods Income Population Taste and preferences Seasonality

Demand Shifters Demand shifters: Population 10 20 30 40 50 Quantity $1 $2 $3 $4 $5 Price Q2 Price Quantity 1 Quantity 2 $1 50 60 $2 40 50 $3 30 40 $4 20 30 $5 10 20 Q1 Demand shifters: Population Consumer taste and preference Income Price of substitutes Price of complements

Demand Elasticity What is elasticity of demand? Classifying the sales response Elastic: the percent change in sales response is greater than the percent change in price Inelastic: the percent change in sales response is less than the percent change in price Unitary: The percent change in sales response equals the percent change in price

What does this tell a business manager? Price Elasticity % change in quantity Ep = % change in price For example, if the price of caviar increases from $20 to $25 per pound and the quantity demand declines from 100 pounds to 50 pounds, what is the price elasticity of caviar? % change in price of caviar % change in quantity of caviar Ep = = +25% -50% = -2 What does this tell a business manager?

Cross-Price Elasticity % change in price of a competitor’s or complementary product % change in quantity Ecp = For example, if the price of crackers increases from $0.50 to $1.00 per pound and caviar sales decrease from 100 pounds to 80 pounds, what is the cross-price elasticity of caviar to crackers? % change in price of crackers % change in quantity of caviar Ecp = = +100% -20% = -0.2 What does this tell a business manager?

What does this tell a business manager? Income Elasticity % change in income % change in quantity Ey = For example, if consumers’ incomes increase from $30,000 to $33,000 and caviar sales increased from 100 pounds to 120 pounds, what is the income elasticity of caviar? % change in income % change in sales of caviar Ey = = +10% +20% = +2 What does this tell a business manager?

Relationship Between Price, Total Revenue, and Elasticity Ep Elasticity Effect on total revenue < 1 Inelastic Price rise → total revenue up Price decline → total revenue down = 1 Unitary Price rise → total revenue unchanged Price decline → total revenue unchanged >1 Elastic Price rise → total revenue down Price decline → total revenue up

Why Demand for a Single Food Is Elastic Sales (Quantity Demanded) Price A B C D E A: all food items B: all dairy product C: all ice cream D: all vanilla ice cream E: Haagen-Dazs vanilla ice cream

Discussion Topics Explain how the combination of the consumers’ desire for utility maximization and the scarcity of resources available to meet them leads to competition in the marketplace and greater happiness by all members of society. Define the terms utility, marginal utility, and the principle of declining marginal utility as used by economists. Explain how these terms lead to people consuming spinach.

Discussion Topics 3. Explain why price is the best allocator of resources in a free market. Explain how price allocates non-scarce resources in a free market. 4. Explain why economists made a distinction between consumers who are willing to and able to buy a product when they talk about effective demand.

5. Explain why the law of demand makes sense for consumers who are always seeking to maximize their total utility from the products they consume. When is consumer demand fully satisfied? Identify and explain the factors that influence consumer demand. Which indicate a shift in consumer demand? Explain why shifts in consumer demand are important to agribusiness managers. What should a manager do if a shift in consumer demand for his or her product is found?

7. Explain why a manager of a fertilizer company needs to pay attention to changes in consumers’ demand for chicken dinners with mashed potatoes, and the value of the dollar in foreign currency exchanges? 8. Explain why an agribusiness manager should know if the demand for his or her products is elastic or inelastic. How does it help the firm achieve higher profits?

What does it mean to an agribusiness firm to find out the income elasticity of its products is positive but less than one? How does this influence the formulation of the firm’s marketing plan and marketing mix? Since few substitute goods exists for food, why don’t farmers just raise prices in order to get themselves a decent income? Do you agree or disagree with this statement? Explain your answer.