IKT434 Topics in Economics

Managerial Economics:
Demand Analysis
Demand
Demand is the quantity of good and services that customers are willing and
able purchase during a specified period under a given set of economic
conditions. The period here could be an hour, a day, a month, or a year.
The conditions to be considered include the price of good, consumer’s
income, the price of the related goods, consumer’s preferences, advertising
expenditures and so on. The amount of the product that the costumers are
willing to by, or the demand, depends on these factors.
There are two types of demand. The first of these is called direct
demand. This model of demand analysis individual demand for goods and
services that directly satisfy consumers desires. The prime determinant of
direct demand is the utility gained by consumption of goods and services.
Consumers budget, product characteristics, individuals preferences are all
important determinants of direct demand.
The other type of demand is called “derived demand”. Derived
demand is the demand resulting from the need to provide the final goods
and services to the consumers. Intermediate goods, office machines are
examples of derived demand. An other good example is mortgage credit.
Mortgage credit demand is not demanded directly, but derived from the
demand for housing.

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IKT434 Topics in Economics

Market demand function

The market demand function for a product is a function showing the
relation between the quantity demanded and the factors affecting the
quantity of demand.

A demand function for the good X can be expressed as follows:

Quantity of product X demanded = Q x = f (the price of X, prices of related
goods, expectations of price
changes, income, preferences,
advertising expenditures and
so on. )

For use in managerial decision making, the relation between quantity

of demand and each demand determining variable must be specified. To
illustrate this, the demand function for automobile industry is

Q = a 1 P + a 2 PI + a 3 I + a 4 POP + a 5 i + a 6 A

This equation states that the number of new domestic automobiles

demanded during a given year (in millions), Q, is a linear function of the
average price of new domestic cars (in $), P, th average price of new
import cars, PI, disposable income per household (in $), population (POP),
average interest rate on car loans (in %), i, and industry advertising
expenditures (in million $).

Assume that the parameters of this demand function is know and

shown in the following equation:

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IKT434 Topics in Economics

Q = - 500 P + 210 Px + 200 I + 20.000 POP + 1.000.000 i +

600 A

Q : the number of new domestic automobiles demanded

P : the average price of new domestic cars (in $),
Px : the average price of luxury cars,
I : disposable income per household (in $),
POP : population
i : average interest rate on car loans (in %),
A : industry advertising expenditures (in million $).

Interpretation of the coefficients:

dQ
= - 500 (automobile demand decrease by 500 for each 1$
dΡ
increase)

dQ
= 200 (a $1 increase in the average price of luxury cars,
dPX

increases demand for the domestic cars by 200.)

Demand Curve
The demand function specifies the relation between the quantity demanded
and all factors that determine demand. But the demand curve expresses the
relation between the price of a product and the quantity demanded, holding
constant all the other factors affecting demand. This can be written as
follows:

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IKT434 Topics in Economics

Q = f (P) Q : demand
P : price

To illustrate this, consider the automobile demand function example

above. Assuming that luxury car prices, income, population, interest rate
and advertising expenditure are all held constant, the relation between the
quantity demanded for domestic cars and price expressed as;

Q = 20.500.000 – 500 P
Q = f (P)

In our analysis, what we usually do is to express price as a function of

demand. P = f (Q). This is called inverse demand function.
The above equation then becomes;
P = 41.000 – 0.002 Q
inverse demand function.
Average oto
price
45

40

35

30

25

20

15

10

0 Q
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

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IKT434 Topics in Economics

Change in the quantity demanded; is defined as the movement along a

single demand curve. This movement reflects change in price and quantity.
Average oto
price
45

40

35 A
30

25
B
20

15

10

0 Q
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

Shift in demand; is the switch from one demand curve to another. Shift in
demand reflects a change in one or more nonprice variables affecting
demand. Example: change in interest rate.
Average oto
price

45

40

35

30

25

20
%6
15

10 %8

5
%10
0 Q
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

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IKT434 Topics in Economics

As seen the figure, a change in interest rate shifts demand for

automobile. A decrease in interest rate increases automobile demand at the
same price.