CERTIFICATE LEVEL

Subject Fundamentals of Business Economics (BA1)

Tharindu Ameresekere MBCS(UK),ACMA(UK),CGMA, Masters in Project Mgmt.(USQ)(Aus),

Lecturer PQHRM(IPM-SL),BSc(Hons) Computing(UK),BCS-PGD(UK), Cert.coach ABNLP

Module Tute 03 - Demand & Supply Management

Code BA1/TA/03
THINK ABOUT IT……

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Tute 3 : Demand & Supply Management

Demand Management

In Netherlands when you walk into a Cheese shop they give you a toothpick to pick different small
pieces of cheese from different types they have. So that way if you taste something you like you
will buy it.

What they are trying to do is make you like what you are selling. Then if you like it you will buy it
as well. That is managing the demand.

Individual demand-How much of a good or service someone intends to buy.

Market demand/“Demand”- The aggregate or effective demand from all consumers in the
market.

This demand needs to be effective in that it is backed by available money, rather than just a
general desire without the necessary financial backing.

When considering demand at a price, we assume that the conditions of demand

(i.e. other variables – like taste / income) are held constant.

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Price demand relationship
Assuming other factors constant (see other factors below), when the price of a product changes,
the demand for it changes. A decrease in price increases its demand (Demand Expansion), and an
increase in price decreases its demand (Demand Contraction). This negative correlation of price-
demand can be shown in a “Demand Curve”

When the demand for a good or service changes in response to a change in its price, the change
is referred to as:

– An expansion in demand where quantity demanded rises due to a fall in price.

– A contraction in demand where quantity demanded falls due to a rise in price.

• The relationship between demand and price can be shown in a diagram and is referred to as a
demand curve. (Note: For such graphs we plot quantity along the horizontal axis and price on the
vertical axis. This may seem the wrong way round to you as we are arguing here that demand
depends on price and we normally have the dependent variable on the vertical axis. However, this
is the accepted approach for economics.)

• Thus, in the diagram below, the downward-sloping demand curve D illustrates the demand for
a normal good. Movements along this curve as the price changes would be called a contraction
in demand (price is rising) or an expansion in demand (price is falling).

The term market demand is the demand from the entire market or the demand for the product
/ service from the entire population.

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Other Factors affecting demand (Conditions of Demand)
Other than price, there are factors that can “shift” the Demand curve to either;

1. The right- increasing the quantity demanded for each price.

2. The left – decreasing the quantity demanded for each price.
Those factors are;

1. Income

Revenue-price relation is generally as described for normal goods. But for Inferior goods, it’s
the opposite effect.

This means for Normal goods the demand is more when the income rises and demand is less
when income falls.

E.g. – BMW Vehicles / Holidays to Disneyland

For inferior goods the demand is more when the income is less and demand is less when
income is more.

E.g – Budget airlines, Discount clothing retailers, Budget shops

*** Exam Tip Alert ***

At the exam if they do not mention which type of product it is you can consider it to be a
Normal Good.

2.Tastes

Tastes, in particular fashions, change frequently and it may make the demand for certain goods
volatile.

Tastes, of course, can be manipulated by advertising and producers to try to ‘create’ markets,
particularly for ostentatious goods, for example, air conditioners which our ancestors survived
perfectly well without. Some goods are in seasonal demand (e.g. cooked meat) even though they
are available all year round, because tastes change (i.e. more salads are consumed in the
summer).

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3. Prices and availability of Substitutes & Complimentary Goods

Substitutes are products that can be used instead of each other. (E.g – Tea & Coffee / Netflix
& Tv Channels)

Complementary goods are those which are used together with each other.
(E.g. - Socks and Shoes, Mobile & Blue Tooth Speaker)

4. Population
An increase in population creates a larger market for most goods, thereby shifting demand
outwards. For instance, an influx of immigrant workers will raise the demand for most essential
goods. Changes in population distribution will also affect demand patterns. If the proportion of
old people relative to young people increases, then the demand for products such as false teeth,
wheelchairs and old people’s homes will increase to the detriment of gripe water, nappies and
cots.

*** In the analysis of how the demand and supply model works, the distinctions between
increase/decrease in demand and expansion/contraction in demand are very important.
Remember:

• If a price change occurs, there will be a movement along the

demand curve and the result will be either an expansion or a
contraction in demand

• If the conditions of demand change, there will be a shift in the

demand curve and the result will be either an increase or a decrease
in demand.

So far we have considered exclusively the influence of price on the quantity demanded, assuming
other factors to be constant. These factors, termed the conditions of demand, will now be
considered, with the price held constant.

Any change in one or more of the conditions of demand will create shifts in the demand curve
itself.

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 • If the shift in the demand curve is outward, to the right, such a
shift is called an increase/rise in demand.

• If the shift in the demand curve is inward, to the left, such a shift is
called a decrease/fall in demand.

It is important to distinguish such increases and decreases in demand that result from a shift in
the demand curve as a whole from expansions and contractions in demand that result from price
changes leading to movements along the demand curve itself.

Right Shift Factors Left Shift Factors

a. More Income (For Normal a. Less Income (For normal goods)

goods) b. Negative taste
b. Positive Taste c. Fall of rice of substitutes
c. Rise of prices of substitutes d. Rise of price of complementary
d. Fall of prices of substitutes goods
e. More population e. Lesser population

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 Ryan Air Case Study

The European budget airline became one of the most flown airlines and extremely profitable
during the Financial crisis of 2008-2009 mainly due to it being cheap and affordable. So the
Demand Curve shifted to the Right.

Price Elasticity of Demand

Elasticity, generally, refers to the relationship between two variables and measures the
responsiveness of one (dependent) variable to a change in another (independent) variable: There
are several types which are useful to economists. Management accountants are particularly
interested in knowing price elasticity of demand as this can give a good indication of the optimal
price for a good or service.

Price Elasticity of Demand = % Change of Quantity Demanded / % Change of Price

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This is a measure of how sensitive the Demand is, to a change in its price. The two main methods
of calculating it using two points on the graph (Arc approaches) are,

a. Non-average arc method – measures % change in price / % change in quantity using the
starting point of price and quantity as the basis for the % calculation

b. Average arc method – measures % change in price / % change in quantity using the
average price and quantity as the basis for the % calculation.

E.g. At a price of 10 USD a Tshirt has a demand of 100 while when the price is increased to 15
USD the demand falls to 80. Calculate the Price Elasticity of Demand.

Non Average Arc Method Calculation Average Arc Method Calculation

Demand Change % : (80-100) / 100 = -20% Demand Change % : (80-100) / 90 = -22.22%

Price Change % : (15-10) / 10 = 50% *** 90 is the average of 80 & 100

= -20% / 50% = -0.4 Price Change % : (15-10) / 12.5 = 40%

*** 12.5 is the average of 10 & 15

= -22.22% / 40% = -0.55

*** Because the Price and Demand Relationship us a Negative the

value of Price Elasticity of Demand will always be a “minus” (-) value.

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Different Types of Demand Elasticities

Illustration of Different Elasticities

D1 shows unit elasticity (% change in demand = % change in price).

D2 shows inelastic demand (% change in demand smaller than % change in

price).

D3 shows elastic demand (% change in demand larger than % change in price).

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*** Note that the value of price elasticity of demand will change as you move along the length of
the straight demand curve.

A normal demand curve will always slope downwards from left to right indicating that a price rise
will lead to a contraction in demand and a price fall will lead to an expansion in demand.

Depending on the Value of the Price Elasticity of Demand there are

different Types of Elasticity.

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*** The more horizontal the Demand curve it means the Demand is
more Elastic. The more vertical the Demand curve it means the
Demand is more in elastic
Some factors can affect the price elasticity of demand.

Factor Description
If a high % of income is spent on the product then the
Proportion of income spent Elasticity is high. If you pay half of salary on Rent,
when rent increases even a little bit you will look for
a new place. But you might not care about the price
of a Toffee being increased.

Substitutes When there are more substitutes available even for a

small change of price people will buy that substitute.
So higher the availability of substitutes the Elasticity
is more.

If the product is a basic necessity then even for a price

Necessities
increase customers will still buy it making the demand
In Elastic.
If the product is bought as a habit then it will be
Habit
bought even when there is an increase of price so the
demand is In Elastic.
Time period considered Longer the time period the market will adjust
according to price changes and therefore the demand
becomes more Inelastic.
In the short term there will not be time to adjust
according to price changes that much so the demand
will be mostly inelastic.

Definition of the market Elasticity depends on the market definition.

For example, the market for a type of apples like red
apples will be price elastic. But in general, for apples
the demand is inelastic since people who eat apples
will not shift to any other product since taste is high.
Furthermore the demand for fruits is even more
inelastic since people will always eat a fruit and finally
demand for Food in general is almost Perfectly
Inelastic.

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The Practical Economist – Exercise
You have been appointed in order to handle marketing of Scoot a leading Asian regional airline.
What steps would you take to ensure that the Price elasticity of Demand is low and people will
stay with the airline ?

**In other words the question is asking how to make sure people stick with this airline even when
prices are increased :

a. Membership Points
b. Special Recognitions for Frequent travel
c. Give a unique service like special solutions for baby travel
d. Special features like Better leg space / bigger seats etc…

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Supply Management
The “supply curve” shows how much the producers/manufacturers are willing to offer for sale,
at different prices over a certain time.

Price-Supply relation
Naturally, they’d want to maximize their profits, hence for higher prices they’ll offer more
products, and vice versa to the market. ( A positive correlation )

For a change of Price the quantity supplied will move up and down along the supply curve.

Conditions of Supply (Other Factors affecting supply)

Similar to Demand, apart from price,

1. Production costs
2. Indirect taxes
3. Technological innovations
4. Raw material/ input prices

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Can “shift” the supply curve to the left or right. ( reduction or increment in quantity supplied by
producers for a given price)

Left Shift of Supply Curve (Same price less supply)

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Right Shift of Supply Curve (Same price More supply)

Price Elasticity of Supply

This is a measure of how sensitive the supply quantity is to the price in the market

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 Worked Example of Price Elasticity of Supply

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 Supply Elasticity Value Description
0 Perfectly Inelastic Supply
0 to 1 Relatively Inelastic Supply
1 Unit Elasticity of Supply
1 to Infinity Relatively Elastic Supply
Infinity Perfectly Elastic

Supply elasticity can be influenced by;

1. Time period considered

2. Factors of production
3. Stock levels
4. Number of firms and competition in the industry.

End of Tute -3

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 Practice Questions
1. Schora PLC sells 1000 small vehicles to Grab PLC every year. This year prices went up by 9%
and it’s revenue went up by 9%. So the demand must be [ Elastic / In Elastic / Perfectly In
Elastic]

2. Higher the income higher the demand for any type of product – TRUE / FALSE

3. When the price of Tea rises the Demand for Coffee will :
a. Fall because they are substitutes
b. Rise because they are complimentary goods
c. Fall because they are substitutes
d. None of the above

4. When the demand becomes more Elastic the demand curve becomes more :

a. Vertical
b. Horizontal

5. Demand for BMW cars will be [ more / less ] inelastic than the demand for vehicles in
general.

6. At a price of 75 USD the demand was 1000 units. If the price increases to 100 USD and the
demand elasticity is-0.3 then what is the new demand ?

7. At a price of 100 USD the demand was 500 and at a price 20 USD the demand was 750. What
is the price elasticity of demand (Average Arc Method) ?

8. If the Demand elasticity was -0.8 and the demand dropped from 1000 to 800 when price was
changed and if the original price was 10 USD, what will the new price be ?

9. Which of these products will have the least supply elasticity

a. Clothes
b. Phones
c. Carrots
d. Cars

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10. At 100 USD 500 were provided and at 200 USD 800 were supplied. What is the PES ?

11.

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