Session 1 Demand Analysis Managerial Economics Professor Changqi Wu

DemandSlide 2 Topics to Be Discussed Concept of consumer demand Elasticity of demand Demand estimation and application

DemandSlide 3 1. Consumer Demand the God? Consumer is...

DemandSlide 4 Individual Demand Quantity demanded: Amount of goods or services that a consumer plans to buy in a given period Quantity demanded and wants Demand reflects not only a consumer’s preference, but also her constraints.

DemandSlide 5 Demand Curve D The demand curve slopes downward demonstrating that consumers are willing to buy more at a lower price. Quantity Price ($ per unit)

DemandSlide 6 Understand the Demand Curve The height of the demand curve: the highest price that a consumer is willing to pay for the last unit of product the value that a consumer attaches to that particular unit of product diminishes. Demand curve slopes downward, consumers are willing to buy more when price falls the good becomes relatively cheaper the consumer’s real income increases

DemandSlide 7 Income: A Non-Price Factor Demand changes along with income at any given price Changes in income shift the entire demand curve Normal goods: A consumer buys more when her income increases Inferior goods: A consumer buys less when her income increases Inferior goods are not low-quality goods

DemandSlide 8 D P Q Q1Q1 P2P2 Q0Q0 P1P1 D’ Q2Q2 Changes in Demand Income Increases At P 1, produce Q 2 At P 2, produce Q 1 Demand Curve shifts right More purchased at any price on D’ than on D

DemandSlide 9 Other Non-Price Factors Prices of related products substitutes complements Advertising Consumer’s tastes Buyer’s expectation

DemandSlide 10 Market Demand Definition: Sum of all buyers’ demand in a well defined market Horizontal sum of demand curves of all individuals

DemandSlide 11 Determining the Market Demand Curve PriceAlanBettyCindyMarket ($)(units)(units)(units)(units)

DemandSlide 12 Summing to Obtain a Market Demand Curve Quantity Price DBDB DCDC Market Demand DADA The market demand curve is obtained by summing the consumer’s demand curves

DemandSlide 13 Determinants of Market Demand Population Impact of baby boomers Demographic distribution Income level and distribution Market saturation

DemandSlide 14

DemandSlide 15 Business Demand Demand for productive input Demand for labor services Market demand and firm-specific demand curve An individual firm may not face the entire market demand curve

DemandSlide 16 Market versus Industry Industry = collection of businesses using similar technology or input to produce goods or services Market = collection of products that are close substitutes aluminum cans and glass bottles Substitutability

DemandSlide 17 Buyer Surplus Difference between the benefit a consumer gets from a product and the price she has paid for Business applications “The more you buy, the more you save”?!

DemandSlide 18 The buyer surplus of purchasing 6 concert tickets is the sum of the surplus derived from each one individually. Consumer Surplus = 21 Buyer Surplus Concert Tickets Price ($ per ticket) Market Price

DemandSlide Demand Elasticities Price elasticity of demand Other elasticities Time factor

Slide Price Elasticity Price elasticity of demand is... responsiveness of the quantity demanded of a good to a small change in its price It measures the percentage change in the quantity demanded for a good or service that results from a one percent change in the price. e p = (  Q/Q)/(  P/P) = (  Q/  P) (P/Q) Because of the inverse relationship between price and quantity demanded, the price elasticity of demand is a negative number.

Slide e p = (-2/3)/(4/12) = -2 Quantity Price Calculating Elasticity

Slide 22 Properties of Price Elasticity Price elasticity is free from unit of measurement It falls between 0 and negative infinity Elastic demand: e p < -1 Unit elastic demand:e p = -1 Inelastic demand: e p > -1

Slide 23 Price Elasticity in Action Price elasticity of telephone services is estimated as e p = -0.1 Price elasticity of demand for electricity is estimated as -0.7 Price elasticity of demand for CDs is estimated as –1.83 What’s about price elasticity of drugs to treat AIDS?

Slide 24 Factors Influencing Elasticity Importance of the product to the buyer Share in the total expenditure Availability of a close substitute Buyer’s prior commitment Search costs for better prices Separation of buyer and payee

Slide 25 Special Cases of Price Elasticity Infinitely elastic demand Completely inelastic demand Unit-elastic demand Linear demand

Slide 26 0 Quantity Price e p = -  An Infinitely Elastic Demand

Slide 27 0 Quantity Price e P = 0 A Complete Inelastic Demand

Slide 28 0 Quantity Price e P = -1 A Unit-Elastic Demand

Slide 29 Linear Demand Curve The steeper the slope of a demand curve, the less elastic the demand, all other things constant; the flatter the slope of a demand curve, the more elastic the demand curve, all other things constant Price elasticity changes along the linear demand curve

Slide 30 0 Quantity Price e p = -1 e p = -  e p = 0 Elastic portion of demand curve Inelastic portion of demand curve Linear Demand Curve

DemandSlide 31 Price Elasticity and Consumer Expenditure DemandIf Price Increases,If Price Decreases,Expenditures: Inelastic (e p >-1)IncreaseDecrease Unit Elastic (e p = - 1) Are unchangedAre unchanged Elastic (e p < -1) DecreaseIncrease

Slide Other Elasticities Income elasticity Cross-price elasticity Advertising elasticity

Slide 33 Income Elasticity Income Elasticity Is... responsiveness of demand of a good to income changes of consumers % change of the demand for an item if the income changes by 1% Properties luxury goodse I > 1 necessity 0 < e I < 1 inferior goods e I < 0

Slide 34 Cross-Price Elasticity Cross-price elasticity is... responsiveness of demand of a good to changes in another good’s price Cross elasticity of demand measures the percentage change in the quantity demanded of one good that results from a one percent change in the price of another good.

DemandSlide 35 Cross-Price Elasticity Properties e c > 0: substitute e c = 0: independent e c < 0:complement

Slide 36 Advertising Elasticity Advertising elasticity is... responsiveness of demand of a good to changes in a seller’s advertising expenditure % change of the demand for an item if seller’s advertising expenditure rises by 1% Advertising elasticity of a firm is larger than that of the market Advertising sales ratio depends on the ratio of adverting elasticity and price elasticity

Slide Time Factor Price elasticity of demand varies with the amount of time consumers have in response to a price change. short-run elasticity long-run elasticity Durable and non-durable goods

DemandSlide 38 Most goods and services: Short-run elasticity is less than long-run elasticity. (e.g. gasoline) Durables goods: Short-run elasticity is greater than long-run elasticity (e.g. automobiles) Short-Run Versus Long-Run Elasticities

DemandSlide 39 Gasoline: Short-Run and Long-Run Demand Curves D SR D LR People tend to drive smaller and more fuel efficient cars in the long-run Gasoline Quantity Price

DemandSlide 40 D SR D LR People may put off immediate consumption, but eventually older cars must be replaced. Automobiles Automobiles: Short-Run and Long-Run Demand Curves Quantity Price

Slide Demand Estimation Where can we find data? How to estimate the value of elasticity? How can we use the elasticity estimates?

Slide 42 Data Sources Data type Time series data Cross-sectional data Data generating methods variables measured  actual purchases (scanner data) versus purchase intentions (survey) conditions of data gathering  uncontrolled (store data) versus controlled experiments conjoint analysis

Conditions of measurement Variable measured Actual purchase Preferences and intentions UncontrolledExperimentally controlled Scanner data, Store data Survey data In-store experiments, Lab purchase Simulated purchase, Conjoint analysis Type of Research Data

Slide 44 Estimation Procedure Choice of a functional form Decision on which variables to be included in the estimation function Estimation method Regression analysis

DemandSlide 45 YearQuantity (Q)Price (P)Income(I) Demand Data

DemandSlide 46 Estimating Demand Quantity Price D D represents demand if only P determines demand and then from the data: Q= P

DemandSlide 47 Estimating Demand Quantity Price D d1d1 d2d2 d3d3 d 1, d 2, d 3 represent the demand for each income level. Including income in the demand equation: Q = a - bP + cI or Q = P +.81I Adjusting for changes in income

DemandSlide 48 Key Learning Points Consumer’s demand for goods and services is influenced by many factors, among them, price, income, advertising, availability of alternatives, etc. Demand curve shows the relationship between price and quantity demanded when non-price factors are assumed constant; changes of non-price factors shift the entire demand curve.

Slide 49 Key Learning Points Elasticity of demand measures the responsiveness of consumers’ demand toward changes in price or in non-price factors such as incomes of buyers. Elasticity estimates are useful in forecasting changes in total revenue of a firm or changes in the quantity demanded caused by changes of multiple factors. Elasticity of demand can be estimated by econometric methods.