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All Rights Reserved to Kardan University 2014 Demand Demand for a good or service is defined as quantities of a good or service that people are ready (willing and able) to buy at various prices within some given time period, other factors besides price held constant. Kardan.edu.af

Demand Function The demand for a commodity arises from the consumers’ willingness and ability to purchase the commodity. Consumer demand theory postulates that the quantity demanded of a commodity is a function of / or depends on the price of the commodity, the consumers’ income, the price of related commodities, and the tastes of the consumer. Qd = f(p){Y,Pr, T, N} Kardan.edu.af

All Rights Reserved to Kardan University 2014 Kardan.edu.af 4 Change in Quantity Demanded Quantity Price P0P0 Q0Q0 P1P1 Q1Q1 An increase in price causes a decrease in quantity demanded.

All Rights Reserved to Kardan University 2014 Kardan.edu.af 5 Change in Quantity Demanded Quantity Price P0P0 Q0Q0 P1P1 Q1Q1 A decrease in price causes an increase in quantity demanded.

All Rights Reserved to Kardan University 2014 Changes in demand Changes in price result in changes in the quantity demanded. – This is shown as movement along the demand curve. Changes in nonprice determinants result in changes in demand. – This is shown as a shift in the demand curve. Kardan.edu.af

All Rights Reserved to Kardan University 2014 Changes in demand Nonprice determinants of demand – Tastes and preferences – Income – Prices of related products – Future expectations – Number of buyers Kardan.edu.af

All Rights Reserved to Kardan University 2014 Changes in demand Change in Buyers’ Tastes -Today’ consumer purchases leaner meats compared to old generations -due to the level of blood cholesterol and body weight Change in Buyers’ Incomes – Normal Goods i.e., shoes, travel, automobiles, education – Inferior Goods – i.e., potatoes, salt Change in the Number of Buyers Change in the Price of Related Goods – Substitute Goods i.e., Carrots can be replaced by cabbage – Complementary Goods i.e., cars and gasoline or electric stove and electricity. Kardan.edu.af

All Rights Reserved to Kardan University 2014 Kardan.edu.af 9 Change in Demand Quantity Price P0P0 Q0Q0 Q1Q1 An increase in demand refers to a rightward shift in the market demand curve.

All Rights Reserved to Kardan University 2014 Kardan.edu.af 10 Change in Demand Quantity Price P0P0 Q1Q1 Q0Q0 A decrease in demand refers to a leftward shift in the market demand curve.

All Rights Reserved to Kardan University 2014 Mathematically Q dx = f(P x, I, P y, N,T)  Q dX /  PX < 0  Q dX /  I > 0 if a good is normal  Q dX /  I < 0 if a good is inferior  Q dX /  P Y > 0 if X and Y are substitutes  Q dX /  P Y < 0 if X and Y are complements Kardan.edu.af

All Rights Reserved to Kardan University 2014 Related concepts The increase in Qx when Px falls occurs because in consumption, the individual consumer substitutes commodity x for other commodities which are now relatively expensive. This is called the substitution effect. In addition, when Px falls, a consumer can purchase more of x with a given amount of money (i.e., the consumer’s real income increases). This is called the income effect. Kardan.edu.af

All Rights Reserved to Kardan University 2014 To remember.. Band wagon effect: “ to keep up with the Joneses” “Me too” Snob Effect: “Me only” Kardan.edu.af

All Rights Reserved to Kardan University 2014 Using elasticity in managerial decision making Controllable factors – Setting the price of its product – Expenditures on advertisement – Quality of its product – Customer service Kardan.edu.af

All Rights Reserved to Kardan University 2014 Using elasticity in managerial making decision…. continued Uncontrollable factors – Level and growth of consumer income – Competitor price decisions – Competitors expenditures on advertisement – Competitor’s Product quality and customer service Kardan.edu.af

All Rights Reserved to Kardan University 2014 Price Elasticity of Demand/Demand sensitivity Analysis Price Elasticity of demand is the measure of the response of the change in the quantity demanded due to the change in the price of the product. Decision: If demand for a product is price inelastic, the firm would not decrease the price of the product, by doing so the firm would decrease its profit. Kardan.edu.af E p = ΔQ d × P ΔP Q

All Rights Reserved to Kardan University 2014 Kardan.edu.af 17 Mathematically Linear Function

All Rights Reserved to Kardan University 2014 Kardan.edu.af 18 Price Elasticity of Demand- Example  Find Ep at point A, B, C and G  Ep=(ΔQ/ ΔP) (P/Q)  At point A, Ep=(0-200/ 6-5) (6/0)  Ep=-200 (6/0)= - indefinite  At point B, Ep= ( /5-4) (5/200)=-5  At point C, Ep=( /4-3) (4/400)=-2  At point G =??

All Rights Reserved to Kardan University 2014 Kardan.edu.af 19 MR and TR based on Elasticity- Example -31,000-1/51, ,2000 1,600-1/ , , , $ 0- indefinite 0$ 6 (5)(5)(4)(3)(3)(2)(2)(1)(1) MR=DTR/DQ TR=P.QEpQP

All Rights Reserved to Kardan University 2014 Kardan.edu.af 20 Graphically Showing Elasticities and MR-TR MR>0 MR<0 TR MR=0 QXQX

All Rights Reserved to Kardan University 2014 Kardan.edu.af 21 Graphically Showing Elasticities and MR-TR MR X PXPX QXQX

All Rights Reserved to Kardan University 2014 Price Elasticity & Firm's Total Revenue Kardan.edu.af PQ E p TR=P.Q Situation 6 0 ∞ $0 Perfectly Elastic More Elastic More Elastic Unitary Elastic Less Elastic Less Elastic inelastic

All Rights Reserved to Kardan University 2014 Kardan.edu.af 900 Price elasticity, total revenue, and Demand TR E E P =1 TR P <1 E P >1 F P ($) QdQd

All Rights Reserved to Kardan University 2014 Reference page 138 Case study 4-3 (Price elasticity of Demand)

All Rights Reserved to Kardan University 2014 Income Elasticity of Demand Kardan.edu.af Income Elasticity of Demand measure the response of the change-in-quantity- demanded due to the change-in-income of the people. Income elasticity of demand suggests the growth potential of a market. It also shows the nature of good. If E y = 0the good is income inelastic and has no potential for the market growth. If E y = +vethe good is a normal good and is income elastic If E y = -ve the good is an inferior good and is income elastic E y = ΔQ d × Y ΔY Q

All Rights Reserved to Kardan University 2014 Kardan.edu.af 26 Income Elasticity of Demand Normal Good Inferior Good Luxuries Good Necessities Good 0 I E  1 I E  1 I 0 < E <

All Rights Reserved to Kardan University 2014 Kardan.edu.af 27 Income Elasticity of Demand  Point Definition  Linear Function

All Rights Reserved to Kardan University 2014 Using Income Elasticity in managerial making decision…. continued Decision: If income elasticity of demand is very low for the firm’s product is Negative, management must know that firm will not benefit from the rising incomes of the people and may want to improve its product or move into new product line with more income elasticity of demand. Kardan.edu.af

All Rights Reserved to Kardan University 2014 Reference page 140 Case study 4-4 (income elasticity of demand)

All Rights Reserved to Kardan University 2014 Cross Elasticity of Demand Cross Elasticity of Demand measures the response of the change-in-quantity demanded of a product due to change-in-the price of competitor’s product. Cross Elasticity of demand shows the rivalry of the product. E cr = +ve the good will be substitute good E cr =-vethe good will be complimentary good E cr = 0the goods are uncorrelated. For Example, P pepesi increase  Q coke increases (Substitute good) P car increase  Q petrol decreases (Complimentary Good) P butter increase  Q books remains the same (Uncorrelated goods) Kardan.edu.af E Cr = ΔQ a × P b ΔP b Q a

All Rights Reserved to Kardan University 2014 Kardan.edu.af 31 Cross-Price Elasticity of Demand Point Definition Linear Function

All Rights Reserved to Kardan University 2014 Kardan.edu.af 32 Cross-Price Elasticity of Demand Substitutes Complements

All Rights Reserved to Kardan University 2014 Using Cross Elasticity in managerial making decision…. continued Decision: If the firm estimated that cross elasticity of demand for its product with respect to the price of competitor’s product is very high. It will be good to quickly respond to the competitor price reduction,otherwise, the firm would lose a great deal of its sale. However the firm would think twice before lowering its price for fear of starting a price war. For reference: read case application 3-7 p#117, 5 th edi. “demand elasiticities for beverages in USA” Kardan.edu.af

All Rights Reserved to Kardan University 2014 Commodity XCommodity Y E XY Substitute Goods: Natural GasElectricity0.80 Coke Pepsi0.40 TeaCoffee0.29 Complementary Goods: CarPetrol-0.50 MobileSIM Card-0.72 PenInk-0.87 Kardan.edu.af

All Rights Reserved to Kardan University 2014 Commodity XCommodity Y E XY Substitute Goods: McIntosh appleGolden delicious apples 0.80 Apples Apple Juice0.50 ApplesEnergy Drinks0.10

All Rights Reserved to Kardan University 2014 Case Study 4-5 page 143 1)Cross elasticity of demand Case study 4-6 page # 147 Price,income and cross elasticities

All Rights Reserved to Kardan University 2014 Kardan.edu.af In case of substitute goods Price of Tea ($)Q.D of Coffee P 0 Tea 10 Q 0 Cofee 100 P 1 Tea 40 Q 1 Cofee 200 Ed=?

All Rights Reserved to Kardan University 2014 Kardan.edu.af In case of complementary goods Price of Petrol Per liters ($) Q.D of Cars P 0 Petrol 10 Q 0 Car 100 P 1 Petrol 40 Q 1 Car 20 Ed=?

All Rights Reserved to Kardan University 2014 Advertising Elasticity of Demand Advertising Elasticity of Demand measure the response of the change- in-quantity-demanded due to the change-in-Advertising expenditures. Decision: If elasticity of sale with respect to advertising is positive and higher than for its expenditures on product quality and customer service then firm must concentrate more on advertising rather than on product quality and customer service. Kardan.edu.af E A = ΔQ d × A ΔA Q

All Rights Reserved to Kardan University 2014 Using Elasticises In Managerial Decision Making-Example  A firm selling coffee brand X and estimated relevant demand regression as follows:  Qx= Px+0.8 I+2.0 Py-0.6 Ps+1.2 A  Qx is sales of coffee brand X, I is disposable income, Py is price of competitive coffee brand, Ps is price of sugar and A is advertising expenditures for coffee brand X.  Suppose: Px=$2, I=$2.5, Py=$1.80, Ps=$0.50 and A=$1 Kardan.edu.af

All Rights Reserved to Kardan University 2014 Kardan.edu.af 41 Using Elasticities In Managerial Decision Making Example page 145  Calculate Qx and the elasticities of sales with respect to each variable in the relevant demand function  Qx= (2)…1.2(1)=2 mn pounds coffee  Calculate the elasticities of the demand for coffee brand X  Ep=-3(2/2)=-3,Ei=0.8(2.5/2)=1, Exy=2(1.8/2)  Exs=-0.6(0.5/2)=-0.15, Ea=1.2(1/2)=0.6  RECALL the Formulae

All Rights Reserved to Kardan University 2014 Kardan.edu.af 42 Using Elasticises In Managerial Decision Making- Example  Next year, the firm would like to increase Px by 5%, A by 12%, I by 4%, and Py 7% whereas Ps fall by 8%.  Determine sales of coffee brand X in the next year.  Qxx=Qx+Qx(DPx/Px)Ep……+Qx(DA/A)Ea  Qxx=2+2(5%)(-3)…..+2(5%)(0.6)  Qxx=2.2 or 2,200,000 pounds

All Rights Reserved to Kardan University 2014 Kardan.edu.af Question Given the demand for beef in the country. Q d = 4850 – 5P b + 1.5P c + 0.1Y Y = National Income= 10,000 P b = Price of Beef = 200 P c = Price of Chicken=100 Find the Following Elasticities of Demand for Beef in the Country: a. Price Elasticity of Demand b. Income Elasticity of Demand c. Cross Elasticity of Demand.

All Rights Reserved to Kardan University 2014 Kardan.edu.af Thanks

All Rights Reserved to Kardan University 2014 Kardan.edu.af 45 The important steps by using Elasticities The analysis of the forces or variables that affect on demand and reliable estimates of their quantitative effect on sales (elasticities) are essential in order for firm to make best operating decisions in shor-run and to plan for its growth in the long-run. The firms can use the elasticities of demand of the variables under their controls to find out best policies as well as to maximize their profits. If the demand for the firm’s product is price inelastic, the firm will want to increase the product price since that would increase its total revenue and reduce its total cost. If the elasticity of the firm’s sales wrt the variable beyod its control or If the cross-price elasticity of demand for the firm’s product is very high, the firm will need to respond quickly to a competitor’s price reduction otherwise losing a great deal of its sales.

All Rights Reserved to Kardan University 2014 Kardan.edu.af 46 The important steps by using Elasticities The size of the price elasticity of demand is larger, the closer and the greater is the number of available substitutes for the commodity. For example, sugar is more price elastic than table salt (e.g. honey) In general, the greater is its price elasticity of demand, the greater will be the number of substitutes For a given price change, the quantity response is likely to be much larger in the long run than short run so the price elasticity odf demand is likely to be much greater in the long run than short run.

All Rights Reserved to Kardan University 2014 Kardan.edu.af Following forces effect the demand of a firm. Own Price of the product Consumer income & taste Price of related goods Numbers of consumers in market Level of Advertisement and promotional policies Availability of credit in the country The demand faced by a firm (cont….)

All Rights Reserved to Kardan University 2014 Kardan.edu.af Q D =F(P, Y, P r,T, A, etc) Where as Q d =Quantity demand of commodity X P=Price of commodity X Y= Income of the household P r =Price of related goods (substitutes or complementary) T=Taste of consumer A= Advertising Mathematically….

All Rights Reserved to Kardan University 2014 Results  Q dX /  I > 0 if a good is normal  Q dX /  I < 0 if a good is inferior  Q dX /  P Y > 0 if X and Y are substitutes  Q dX /  P Y < 0 if X and Y are complements Substitutes Complements

All Rights Reserved to Kardan University 2014 Normal Good Inferior Good Luxuries Good Necessities Good 0 I E  1 I E  1 I 0 < E <

All Rights Reserved to Kardan University 2014 SALES = [(number of print ads) x.34] + [(number of radio ads) x.42]," which allows you to forecast SALES based on easy-to- visualize predictors