MANAGERIAL ECONOMICS

CLASS: MBA 3.5 SEMESTER V

INSTRUCTOR: MS. SAIRA MAJEED
DEMAND ANALYSIS
CHAPTER 4
MARK HIRSCHEY
 BASIS FOR CONSUMER DEMAND

• The ability of goods and services to satisfy consumer wants is

the basis for consumer demand.
Utility:
• The satisfaction derived from the consumption of goods and
services.
Total Utility:
• Total amount of satisfaction derived from the consumption.
Marginal Utility:
• Added utility derived from increasing consumption of a
particular product by one unit.
 TOTAL AND MARGINAL UTILITY
Tacos Total Marginal
consumed Utility, Utility, 30

Total Utility (utils)

per meal Utils Utils
20
0 0
1 10 10

0 1 2 3 4 5 6 7

Units consumed per meal

Marginal Utility (utils)

10
8
6
4
2
0
-2
1 2 3 4 5 6 7
Units consumed per meal
 TOTAL AND MARGINAL UTILITY
Tacos Total Marginal
consumed Utility, Utility, 30

Total Utility (utils)

per meal Utils Utils
20
0 0
10
1 10 10

0 1 2 3 4 5 6 7

Units consumed per meal

Marginal Utility (utils)

10
8
6
4
2
0
-2
1 2 3 4 5 6 7
Units consumed per meal
 TOTAL AND MARGINAL UTILITY
Tacos Total Marginal
consumed Utility, Utility, 30

Total Utility (utils)

per meal Utils Utils
20
0 0
10
1 10 10

8
2 18
0 1 2 3 4 5 6 7

Units consumed per meal

Marginal Utility (utils)

10
8
6
4
2
0
-2
1 2 3 4 5 6 7
Units consumed per meal
 TOTAL AND MARGINAL UTILITY
Tacos Total Marginal
consumed Utility, Utility, 30

Total Utility (utils)

per meal Utils Utils
20
0 0
10
1 10 10

8
2 18
6
3 24 0 1 2 3 4 5 6 7

Units consumed per meal

Marginal Utility (utils)

10
8
6
4
2
0
-2
1 2 3 4 5 6 7
Units consumed per meal
 TOTAL AND MARGINAL UTILITY
Tacos Total Marginal
consumed Utility, Utility, 30

Total Utility (utils)

per meal Utils Utils
20
0 0
10
1 10 10

8
2 18
6
3 24 0 1 2 3 4 5 6 7

4
4 28
Units consumed per meal

Marginal Utility (utils)

10
8
6
4
2
0
-2
1 2 3 4 5 6 7
Units consumed per meal
 TOTAL AND MARGINAL UTILITY
Tacos Total Marginal
consumed Utility, Utility, 30

Total Utility (utils)

per meal Utils Utils
20
0 0
10
1 10 10

8
2 18
6
3 24 0 1 2 3 4 5 6 7

4
4 28
Units consumed per meal

Marginal Utility (utils)

10
2 8
5 30 6
4
2
0
-2
1 2 3 4 5 6 7
Units consumed per meal
 TOTAL AND MARGINAL UTILITY
Tacos Total Marginal
consumed Utility, Utility, 30

Total Utility (utils)

per meal Utils Utils
20
0 0
10
1 10 10

8
2 18
6
3 24 0 1 2 3 4 5 6 7

4
4 28
Units consumed per meal

Marginal Utility (utils)

10
2 8
5 30 6
0 4
6 30 2
0
-2
1 2 3 4 5 6 7
Units consumed per meal
 TOTAL AND MARGINAL UTILITY
TU
Tacos Total Marginal
consumed Utility, Utility, 30

Total Utility (utils)

per meal Utils Utils
20
0 0
10
1 10 10

8
2 18
6
3 24 0 1 2 3 4 5 6 7

4
4 28
Units consumed per meal

Marginal Utility (utils)

10
2 8
5 30 6
0 4
6 30 2
-2 0
MU
7 28 -2
1 2 3 4 5 6 7
Units consumed per meal
 TOTAL AND MARGINAL UTILITY
TU
Tacos Total Marginal
consumed Utility, Utility, 30

Total Utility (utils)

per meal Utils Utils

0 0
20
Observe
10 Diminishing
1 10 10

8
2 18 Marginal
6
3 24 0 1
Utility
2 3 4 5 6 7

4
4 28
Units consumed per meal

Marginal Utility (utils)

10
2 8
5 30 6
0 4
6 30 2
-2 0
MU
7 28 -2
1 2 3 4 5 6 7
Units consumed per meal
CONSUMER CHOICE
MARGINAL RATE OF SUBSTITUTION

• Along the indifference curve we are substituting some units of

commodity for another
• Marginal Rate of substitution tells us how much one
commodity is substituted for how much of another
commodity.
• In other words it tells us at what rate a consumer is willing to
substitute one commodity for another.
• It is a common idea that the more of a good available to you,
the more the tendency for you to give up that good in order to
increase the consumption of the scarce good.
•   means the MRS falls as we have more of X and less of Y.
It
• So, MRS = - (slope of the indifference curve)
• MRS = -()
• Since the rate at which you substitute between different goods
cannot be negative, therefore MRS is taken as an absolute
value i.e. a positive value.
PERFECT SUBSTITUTES
 BUDGET LINE

•  Y=I
Slope of the Budget line = -()
WHY SO???
Remember Y=a+bX
Y=I
Y=I-
Y= X
LAW OF DEMAND- A CLOSER LOOK

The Total Price Effect = Income effect + Substitution effect

The Income Effect:

• When there is an increase in the potential purchasing power of
consumers as a result of fall in price of X. the consumer feels
as if his income has increased. This is called the income effect.
The Substitution Effect:
• When there is fall in price of good X, making X cheaper than
before; while the price of Y remain unchanged, there will be
natural tendency of on the part of consumers to buy more of a
cheaper good i.e. X.
• This phenomenon is called The Substitution effect.
 UTILITY MAXIMIZING RULE

•Slope
  of indifference curve = Slope of the Budget Line

=
Utility is maximized when products are purchased at relative
prices that equal the relative marginal utility derived from the
consumption.
CONSUMPTION EFFECT OF CHANGES IN
BUDGET AND RELATIVE PRICES
 INCOME AND SUBSTITUTION EFFECT
FOLLOWING A REDUCTION IN PRICE OF GOODS
OPTIMUM MARKET BASKETS FOR
CONSUMPTION
DEMAND SENSITIVITY
ANALYSIS
ELASTICITY
ELASTICITY
• The concept of elasticity simply involves the percentage
change in one variable associated with a given percentage
change in another variable.
• The elasticity concept is also used in finance where the impact
of changes in sales on earnings under different production
levels and different financial structures are measured by an
elasticity factor.
• Elasticities are also used in production and cost analysis to
evaluate the effects of changes in input and output and the
effect of output changes on cost.
• Factors such as price and advertising that are within the
control of the firm are called endogenous variables.
• Factors outside the control of firms such as consumer incomes,
competitor prices and the weather are exogenous variables.
• The effect on changes in both types of variables/influences
must be understood if the firm is to respond effectively to
changes in the economic environment.
• For example, a firm must understand the effects on demand of
changes in both prices and consumer incomes, to determine
the price cut necessary to offset a decline in sales caused by a
business recession.
• Similarly, the sensitivity of demand to changes in advertising
must be quantified if the firm is to respond appropriately with
price or advertising changes to an increase in competitor
advertising.
• Determining the effects of changes in both controllable and
uncontrollable influences on demand is the focus of demand
analysis.
 ELASTICITY IS MEASURED IN TWO
WAYS
• Point Elasticity:
• Point elasticity measures elasticity at a given point on a
function. This is used to measure the effect on a dependent
variable Y of a very small or marginal change in an
independent variable X.

• Arc Elasticity:
• To assess the effects of large scale changes in X, the concept
of arc elasticity is used. It measures average elasticity over a
given range of a function.
•  Point Elasticity =

• Also,
• If 5 a 1% increase in X will lead to a 5% increase in Y.
• Therefore,
  when , Y changes in the same positive or negative
direction as X.
• Conversely, when , Y changes in opposite direction of changes
in X.
• For example if -3, a 1% increase in X will lead to a 3%
decrease in Y, and a 1% decrease in X will lead to a 3%
increase in Y.
 ADVERTISING ELASTICITY

•  Advertising Elasticity =

• If 2 we say that a 1% change in advertising expenditures lead

to a 2 % change in demand.
• The elasticity is positive, indicating a direct/positive
relationship between advertising and quantity demanded.
 PRICE ELASTICITY OF DEMAND

•  Point Price Elasticity =

EXTREME CASES OF ELASTICITY
VARYING ELASTICITY ON A DEMAND
CURVE
RELATIONS AMONG PRICE ELASTICITY
AND MARGINAL AND TOTAL REVENUE
ELASTICITY AND TOTAL REVENUE
PRICE ELASTICITY AND OPTIMAL PRICE
POLICY