Demand Analysis II

Kavi B. Nowbutsing
Senior Lecturer
 Supply-induced demand
• Elster and Damasio (1995) concluded that
emotions are a necessary part of our
psychological make-up; without them we
become indecisive, depressed and social
misfits.
• Therefore, it is necessary to ensure
commitment, to convince other consumers
that we are trustworthy, so that they will
engage in transactions with us.
 The Law of Demand
• Why the law of demand holds?
Factors affecting demand
 Controllable Factors
• Price: The firm can represent a single-product or
multiple-product (Revenue)
• Product: It is the perceived quality of the product
that affects quantity demanded (Cost)
• Promotion: refers to communication by the firm
with its intended customers, ultimately aimed at
persuading them to buy the product (Cost)
• Place: It refers to distribution strategy, in particular
the selection of distribution channels (Cost)
 Uncontrollable Factors
• Income: The relationship with quantity
demanded can be direct or inverse depending
on whether the product is normal or inferior.
• Tastes: Difficult to define and vary inter-
temporally (over time) and inter-spatially (across
locations).
• Government Policy: bans, indirect taxes or
subsidies, health warnings, promotion
regulations, licences, age restrictions,
restrictions on times and places of consumption.
 Uncontrollable Factors (Cntd)
• Competitive factors: Price is not the only
relevant factor here. An example of this is the
competition between Coke and Pepsi, who have
a virtual duopoly of the cola market.
• Demographic factors: These refer not only to
the size of population, but also to its structure.
In particular the ageing of the population
affects demand in many ways because older
people demand more health services and
pensions.
 Uncontrollable Factors (Cntd)
• Climatic factors: Weather, rainfall, temperature
are important.
• Seasonal factors: Many products have a demand
that varies according to season of the year, like
air travel, hotels, car rental, jewellery and
restaurants.
• Macroeconomic factors: These include income,
discussed earlier, and also interest rates,
exchange rates, inflation rates and
unemployment rates.
 Uncontrollable Factors (Cntd)
• Institutional factors: These include a wide
variety of effects; the physical infrastructure of
roads, railways and telecommunications is
relevant, so are political systems, legal
systems, education systems, housing systems,
religious systems and family systems.
• Technological factors: Primarily affect supply
but also affect demand indirectly. Mobile
phones best serve this purpose.
 Uncontrollable Factors (Cntd)
• Price of substitutes and complements: A
substitute is a product with similar perceived
functions or attributes, i.e. cars andpublic
transport. Complementary products are
consumed together, i.e. cars and petrol.
• Expectations of changes in any of the above
factors
 Elasticity
• Four main types of elasticity that tend to be
measured and examined are: price,
promotion, income and price of a related
product.
• Q = f(P; A; Y; P*)
 Price Elasticity of Demand
• PED is the percentage change in quantity
demanded in response to a 1 per cent change
in price.
Assume:
Q = 18 – 2P
Q = 10 and P = 4
Calculate PED?
 Determinants of PED
• Availability of substitutes: the more close a
substitute(s) a product has the more elastic is
its demand.
• Proportion of income spent on the product:
The higher this is, the more elastic the
demand, other things remaining equal.
• Time frame: Demand tends to be more elastic
in the longer term, because it may take time
for consumers to switch to different products.
 Promotional Elasticity
• Advertising Elasticity of Demand: refers to the
percentage change in quantity demanded in
response to a 1 per cent change in advertising.
• AED is expected to be positive, since we would
expect consumers to react positively to
promotion or advertising.
 Income Elasticity
• Income elasticity (YED) is the percentage
change in quantity demanded in response to a
1 per cent change in income.
 Cross Elasticity
• Cross elasticity (CED) refers to the percentage
change in the quantity demanded of one
product in response to a 1 per cent change in
the price of another product.
• CED can be positive or negative.
• Substitute or Complement?