MARKET DEMAND ANALYSIS

&

APPLICATIONS

Lecture 2

Prepared by:

Dr G. Makuyana
+263 782 314 111
+263 715 892 262
gmakuyana@gzu.ac.zw
  Demand is the quantity of a good or
service that customers are willing and
able to purchase during a specified period
under a given set of economic conditions.
DEMAND  The time frame might be an hour, a day,
THEORY: a month or a year.
 Conditions to be considered include the
AN price of the good in question, prices and
availability of related goods, expectations
OVERVIE of price changes, consumers‘ incomes,
W consumers taste and preferences,
advertising expenditures and so on.
• The 'Law Of Demand' states that, all other
factors being equal, as the price of a good
or service increases, consumer demand
for the good or service will decrease, and
vice versa.
2
DEMAND THEORY: AN OVERVIEW
(CONT’) 3

Dx = f(Px, Py, M, T, W, N, Pr, E, …..)

Where Dx = quantity of commodity X demanded per unit of time,

Px = Price of X,
Py = Mean price of all other substitute commodities,
M = consumer‘s income
T = consumer‘s Taste
W = Wealth of the consumer
N = Population size
Pr = Promotional activities (such as advertising,…
E = Consumer expectations
Change in Quantity Demanded
Price
A to B: Increase in quantity demanded

A
10

B
6

D0

4 7 Quantity
Change in Demand
Price
D0 to D1: Increase in Demand

6
D1

D0
7 13 Quantity
Market Supply Curve
 The supply curve shows the amount of a good that will
be produced at alternative prices.
 Law of Supply
 The supply curve is upward sloping

Price
S0

Quantity
Factors that affect a change in supply

• Input prices
• Technology or
government regulations
• Number of firms
• Substitutes in production
• Taxes
• Producer expectations
Change in Quantity Supplied
Price A to B: Increase in quantity supplied

S0
B
20

A
10

5 10 Quantity
Change in Supply
S0 to S1: Increase in supply
Price

S0

S1

5 7 Quantity
 Market Equilibrium

 Balancing supply and demand

QxS = Qxd

 Steady-state
Market disequilibrium: Impact of a Price Ceiling

Price
S

PF

P*

Ceiling
Price
Shortage D

Q* Quantity
Qs Qd
Market disequilibrium: Impact of a Price Floor

Price Surplus S
PF

P*

Qd Q* QS Quantity
CONSUMER BEHAVIOUR: AN OVERVIEW
13
 Consumer behaviour theory rests upon three basic
assumptions regarding the utility tied to consumption.
1) Nonsatiation principle – more of everything is
better.
2) Completeness principle – ability to compare and
rank the benefits tied to consumption of various
goods and services.
3) Transitivity principle – ability to think
logically/order the desirability of various goods and
services.
Consumer behaviour CONT’
14

• Utility Function (U) :- function is a descriptive statement that relates

satisfaction or well-being to the consumption of goods and services.

• The utility of a basket of goods depends on the quantities of the

individual commodities. If there are ή commodities in the bundle with
quantities x1, x2, ----------------xn, then utility is U = f (x1, x2,
-----------------------xn).

• Marginal Utility (MU):- measures the added satisfaction derived from a

one unit increase in consumption of a particular good or service,
holding consumption of other goods and services constant. The
relationship between demand and marginal utility can explain the
behaviour of demand in relation to price.
 Law of Diminishing Marginal
Utility (DMU) :- states that, as
an individual increases
consumption of a given product
within a set period of time, the
managerial utility gained from
consumption eventually
declines.

 According to law of Diminishing

Marginal utility, a consumer
tries to equalise marginal utility
of a commodity with its price so
that his satisfaction is
maximised: Mux = Px.
15
 Elasticity of demand

 A measure of the
responsiveness of one
variable to changes in
another variable
 It is the percentage
change in one variable
that arises due to a given
percentage change in
another variable.
 The elasticity measure
does not depend on the
units in which we
measure the variables.

16
 Own Price Elasticity of Demand 17
[PED]
 Own price elasticity: A measure of the responsiveness
of the quantity demanded of a good to a change in the
price of that good;

 Demand is elastic if the absolute value of the own price

elasticity is greater than 1.

 Demand is inelastic if the absolute value of the own price

elasticity is above zero but less than 1.

 Demand is unitary elastic if the absolute value of the own

price elasticity is equal to 1.
 If demand is elastic, an
increase (decrease) in price
will lead to a decrease
(increase) in total revenue.

Elasticity If demand is inelastic, an

increase (decrease) in price
and Total will lead to an increase
Revenue (decrease) in total revenue.

Total revenue is maximised

at the point where demand
is unitary elastic.

18
 Factors Affecting the Own Price 19
Elasticity
 Available substitutes
 The more substitutes available for the good, the more elastic the demand for
it. A price increase leads consumers to substitute toward another product,
thus reducing considerably the quantity demanded of the good.
 When there are few close substitutes, demand tends to be relatively
inelastic.
 Time
 Demand tends to be more inelastic in the short term than in the long term.
 The more time consumers have to react to a price change, the more elastic
the demand for the good. Time allows the consumer to seek out available
substitutes
 Expenditure share
 Goods that comprise a relatively small share of consumers’ budgets tend to
be more inelastic than goods for which consumers spend a sizable portion of
their incomes.
 Selected Own Price Elasticities
20

Market Own Price Elasticity

Transportation -0.6
Motor Vehicles -1.4
Motorcycles and bicycles -2.3
Food -0.7
Cereal -1.5
Clothing -0.9
Women’s clothing -1.2
 Selected Short- and Long-Term Own
Price Elasticities 21

Market Short-Term Own Long-Term Own

Price Elasticity Price Elasticity
Transportation -0.6 -1.9

Food -0.7 -2.3

Alcohol and -0.3 -0.9

tobacco
Recreation -1.1 -3.5

Clothing -0.9 -2.9

 Cross-Price Elasticity
[CES]
 Cross-price elasticity: A measure of the
responsiveness of the demand for a good to
changes in the price of a related good; the
percentage change in the quantity
demanded of one good divided by the
percentage change in the price of a related
good.

 The cross-price elasticity is positive

whenever goods are substitutes.

 The cross-price elasticity is negative

whenever goods are complements.
22
 Income Elasticity of demand 23
[YED]

• Income elasticity: A measure of the responsiveness of the

demand for a good to changes in consumer income; the
percentage change in quantity demanded divided by the
percentage change in income.
• The income elasticity is positive whenever the good is a
normal good.
• The income elasticity is negative whenever the good is an
inferior good.
Advertising Elasticity 24

The own advertising elasticity of

demand for good X defines the
percentage change in the
consumption of X that results
from a given percentage change
in advertising spent on X.
 Selected Long-Term Advertising
Elasticities 25

Long-Term Advertising Elasticity

Clothing 0.04

Recreation 0.25
 The demand for personal computers can be characterised
by the following marginal elasticities: price elasticity =
-5, cross-price elasticity with software = -4, and income
elasticity = 2.5.

  Comment on the price, cross and income elasticities.

 What advice would u give to the company producing
personal computers to increase total revenue?
 Write the demand function for personal computers.

Example 26
Example: Find price, income and cross price
elasticities from the following yearly data
27

Year Price of Butter Quantity Real Income Price of

Purchased Margarine

1 1.10 200 11500 0.90

2 0.99 205 10500 0.65

 Importance of elasticity of
demand 28
1. Importance to producer: helps in planning – production & marketing:
Market segmentation
Price discrimination
Promotional activities (determination of expenditures on advertising,
packaging, customer service, product quality…)
2. Importance to government: helps in planning the following:
Subsidies
Taxes and revenue generation
Analysis of tax incidence
3. Importance on international trade and terms of trade analysis:
To firms it helps in selecting profitable export markets;
To the country, the Marshall-Lerner condition applies – the condition states
that for a currency devaluation to have a positive impact on trade balance,
the sum of price elasticity of imports and exports must be greater than 1.
Importance of elasticity of demand cont’

4. Analysis of consumption and 29

savings behaviour
 Explain how the concept of elasticity can
be of importance to the following people:

Bank manager

Discussion General manager of Delta

questions Beverages/Quest Motors

Director of academic programmes at a

university

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END

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