Economics for Managerial Decision Making

DEMAND THEORY

Tharun G (09)
Rakesh (15)
Periyathambi Rajan (19)
Prafful Kothari (20)
Sriram. V (27)
 Meaning of Demand

Demand for a commodity refers to the desire backed by

ability to pay and willingness to buy it .

Dx = F (Px ,Ps ,Y ,T ,W)

 Law of Demand

The greater the amount sold, smaller must be

the price at which it is offered, in order that it
may find purchases, in other words the
amount demanded increases with fall in price
and diminishes with rise in price
-Alfred Marshall
 Assumptions of Law of Demand
• No change in consumer’s income
• No change in consumer’s taste & preferences
• No change in price of other goods
• No new substitutes for the goods have been
discovered
• People do not feel that present fall in price is
prelude to further decline in price
 Demand Schedule & Curve

Demand for chocolates DD – Demand curve

Price (In Rs) Quantity

5 10
4 20
3 30
2 40
1 50

© OnlineTexts.com p. 5
Market Demand versus Individual Demand

• Market demand refers to the sum of all

individual demands for a particular good or
service.

• Graphically, individual demand curves are

summed horizontally to obtain the market
demand curve.
Individual Demand Curves Market Demand Curve
 Exceptions to the law of demand

• Expectations regarding future prices

• Veblen effect

• Giffen paradox
Changes in Quantity Demanded
A rise in the price of
coffee grains results in a
movement along the
demand curve.
 Shifts in Demand Curve
Price of
tea

Increase
in demand

Decrease
in demand
Demand
curve, D2
Demand
curve, D1
Demand curve, D3
0 Quantity of
Coffee
Shifts in the Demand Curve
 Determinants of Demand

• Taste & preferences of consumer

• Income of the consumer

• Price of Substitutes

• Number of Consumers
 Determinants of Demand

• Taxes

• Distribution of Income

• Climate & weather conditions

• State of Business

• Consumer Innovativeness
 Elasticity of Demand

The Elasticity (or responsiveness ) of demand in a

market is great or small according as the amount
demanded increases much or little for a given fall in
price and diminishes much or little for a given rise in
Price
 Types of Elasticity
• Price Elasticity
• Income Elasticity
• Cross Elasticity
• Advertising elasticity
 Price Elasticity of Demand
1.Percentage Method

Where ,
-- Price of the Commodity
-- Quantity demanded of the Commodity
-- Change in quantity demanded
-- Change in Price
 Price Elasticity of Demand

Price
Infinitely Elastic Demand

E
P
-
P* D

Quantity
 Price Elasticity of Demand
Completely Inelastic Demand
Price

P
E 0

Q* Quantity
 Unit Elastic demand
P

20
a EP  1

b
8
D

O 40 100
Q
 Relatively Elastic demand

EP  1
P(Rs)
b
5
a
4 D

0 10 20
Q (millions of units per period of time)
 Relatively Inelastic demand

8
a
EP  1
P(Rs)

b
4 D

0 10 15
Q (millions of units per period of time)
 2.Point Method
• The elasticity of the linear demand curve at
point A is ratio of lower segment AD1 to the
upper segment AD i.e.

Ep = Lower segment of the DD curve

Upper segment of the DD curve
 Point Elasticity of Demand
D Ep =

Price B Ep >1

A Ep = 1
P

C Ep <1

Ep = 0
0 Q Quantity
D1
 3.Total Outlay Method
Types of elasticity of Demand
Change in Price
ep = 1 ep < 1 ep > 1

total outlay
fall in price remains constant total outlay falls total outlay rises

total outlay
rise in price total outlay rises total outlay falls
remains constant
 4.Arc Elasticity
• For this problem in the measurement of Arc
elasticity
• Arc Ep = change in Q (P1 + P2)/2
change in P (Q1 + Q2)/2
 Arc Elasticity
P
D

A
20

B
8
D

O 40 100
Q
 Income elasticity
• The rate of response of quantity demand due
to a raise (or lowering) in a consumers
income.

• IEoD = (% Change in Quantity Demanded)/

(% Change in Income)
• Negative scores are Important
 Income elasticity(contd..)
• If IEoD > 1 then the good is a Luxury Good and
Income Elastic
• If IEoD < 1 and IEOD > 0 then the good is a
Normal Good and Income Inelastic
• If IEoD < 0 then the good is an Inferior Good
and Negative Income Inelastic
 Cross Elasticity
• the rate of response of quantity demanded of
one good, due to a price change of another
good.
• Applicable Substitutes and Complementary
Goods
• CPEoD = (% Change in Quantity Demand for
Good X)/(% Change in Price for Good Y)
 Cross Elasticity(contd..)
• If CPEoD > 0 then the two goods are
substitutes
• If CPEoD =0 then the two goods are
independent (no relationship between the
two goods
• If CPEoD < 0 then the two goods are
complements
 Advertising elasticity
• The change in sales that results from each
monetary unit (e.g. each pound or dollar) that
is spend on advertising.
• (% Change in Quantity Demanded)/
(% Change in Advertising Cost)
• Interpretation Similar to Income Elasticity .
Negative changes are to be noted.
Importance of Elasticity of Demand
• Price Discrimination
• Levy of taxes
• International Trade
• Determination of volume of output
• Fixation of Wages for labor
• Poverty in midst of plenty
THANK YOU