Understanding Consumer Demand

Basics of Consumer Demand Scarcity Price allocates scare resources Two principles of consumer behavior Consumers always select the item that gives highest level satisfaction (utility maximization) Consumers always select the item that gives highest level satisfaction (utility maximization) Additional satisfaction from consumption of each additional unit declines (diminishing marginal utility) Additional satisfaction from consumption of each additional unit declines (diminishing marginal utility)

Factors Influencing Consumer Demand What does demand mean? What does the law of demand mean?

Factors Influencing Consumer Demand Seven factors affecting the demand Price of product Price of product Price of competitor’s products Price of competitor’s products (substitute products) Price of complement goods Price of complement goods Income Income Population Population Taste and preferences Taste and preferences Seasonality Seasonality

Demand Shifters Quantity $1 $2 $3 $4 $5 Price Q1 Q2 Price Quantity 1 Quantity 2 $ $ $ $ $ Demand shifters Population Consumer taste and preference Income Price of substitutes Price of complements, etc

Demand Elasticity Elastic Inelastic Unitary Classifying sales response What is Elasticity?

Price Elasticity % change in price % change in quantity E p =

Price Elasticity Example: Price of caviar increases from $20 to $25 per pound and 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 E p = = +25% -50% = -2 What this tells a business manager?

Cross-Price Elasticity % change in price of a competitor’s or complementary product % change in quantity E cp =

Cross-Price Elasticity Example: Price of cracker increase from $0.50 to $1.00 per pound and caviar sales decrease from 100 pounds to 80 pounds, What is cross- price elasticity of caviar to crackers? % change in price of crackers % change in quantity of caviar E cp = = +100% -20% = -0.2 What this tells a business manager?

Income Elasticity % change in income % change in quantity E y =

Income Elasticity Example: Consumers 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 E y = = +10% +20% = +2 What this tell a business manager?

Relationship Between Price, Total Revenue, and Elasticity E p 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 0 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