LECTURE 3 FACTORS WHICH DETERMINE THE DEMAND OF GOODS AND SERVICES WITH SPECIAL ATTENTION TO PRICES Demand Analysis

1. FACTORS WHICH DETERMINE THE DEMAND 1.1 The impact of the price on the demand 1.2 The impact of incomes on the demand 1.3 The impact of advertising on the demand 1.4. The impact of the price and advertising of other goods on the demand for the investigated good 2. ELASTICITY OF DEMAND 2.1. Characteristics of elasticity of demand Price-elasticity of demand Influence of the price-elasticity on sale revenue (incomes from sale) Income-elasticity of demand Elasticity of demand with respect to expenditures on advertisements Cross-price elasticity of demand Cross elasticity of demand with respect to advertisement 2.2. Calculations of elasticity of demand The simplest method: quotient of the demand and price growth Derivative method 3. DEMAND FUNCTIONS 3.1. Linear function – estimation and properties 3.2. Power functions - estimation and properties Where are we?

Definition of the demand Demand - quantity or value of goods and services purchased by the buyers at a given price at a specified time

The law of demand The law of demand, otherwise called the Marshal law, indicates the multidirectionality of changes in the demand and price: an increase in the price causes a decrease in the demand and vice versa - a decrease in the price causes an increase in the demand This regularity may be presented as the demand curve - the diagram referring to the magnitude of the demand for goods and services depending on their price

Demand curve – scutter diagram chart of relationship between price and demand

Exceptions It is not to all goods that the demand reacts so strongly. Actually, there is quite an extensive group of goods called the necessities (essential goods) for which the demand insignificantly responds to changes in prices. These goods comprise the basic food articles (dairy products, grain products –bread etc.), rental fees, and often also insurances

Rigid (stiff) demand In theory, the rigid demand, according to its name implication, is the demand which does not change at all under the impact of price. In practice, however, we do not observe such cases. We can only speak about slightly significant or (statistically) insignificant changes of the demand. More pertinent is the name necessities which according to the definition is characterized by the demand changes lower than the price changes

Paradoxes There are also situations when an increase in the price causes an increase in the demand and vice versa. These are called economic paradoxes. The best known are the paradoxes of Giffen, Veblen and speculative paradox

Giffen paradox Giffen paradox - Robert Giffen noticed that in the case of bread consumption the multitude of requirements was increasing along with the price of bread, contrary to the law of demand. Generally, the Giffen paradox refers to the essential goods or the lower order goods – inferior goods (bread, potatoes, low quality equivalents of normal goods - foodstuff), called the Giffen goods and people having low incomes

Veblen paradox Veblen paradox- refers to luxury, „snobbish” goods (hence it is sometimes colloquially called the snob paradox). The consumers purchase expensive, high quality goods (sometimes aimed at their ostentatious consumption which they treat as a sign of their high material and social status). Veblen goods are the goods for which there will be a fall in demand if the price falls because of the belief that the quality has fallen

Veblen-Giffen paradox We could say that while the Giffen goods are purchased despite their high price, the Veblen goods are purchased because their price is high (the goods utility depends not only on their properties but also on their prices which are identified with the quality).

Speculative paradox The speculative paradox- refers to expectations as to possible future movements of prices. In the case of an increase in prices we are willing to buy goods if we expect further increases in their prices (with the aim to escape from growing prices or to sell the goods for a profit). If the price drops and we expect some further reduction trends, we are willing to sell our goods as early as possible, and in the case of taking a decision to buy them we shall postpone such decision to buy the goods for the lowest price. The speculative paradox may be observed on capital markets, where an increase in the shares price enhances the expectations as to the bull market and may cause increased purchases of shares, whereas the reduction of prices, perceived as a forecast of approaching fall, will cause the decision to sell the shares to protect oneself against a higher loss