Demand Analysis II

Elasticity of Demand and Some Other Topics

Agenda
● Movement along a demand curve
● Shift in demand curve
● Price elasticity of demand
● Income elasticity of demand
● Cross price elasticity of demand
● Demand forecasting
What causes movement along a
Demand Curve?
Movement Along a Demand Curve
● Signifies a change in the quantity
demanded for a product due to a change
in its price, while other factors affecting
demand remain constant.
● Helps understand how consumers
respond to price changes.
● Demonstrates the Law of Demand in
action.
● Referred to as expansion or contraction
of demand.
What causes shift in Demand
Curve?
Shift in Demand Curve
● Represents a change in the overall
demand for a product at every price
level, caused by factors beyond price
alone.
● Shows how external factors influence
quantity of a good consumers are
willing to buy.
● Referred to as increase or decrease in
demand.
Factors Influencing Demand Shifts
1. Consumer income
2. Tastes and preferences
3. Expectations about the future
4. Prices of related goods (substitutes and complements)
5. Advertising
6. Government policy
What is elasticity?
Elasticity

Refers to the measurement of how responsive the

quantity demanded of a good or service is to changes in
various factors, typically changes in price
Price Elasticity of Demand
Price Elasticity of Demand
Measures how sensitive the quantity demanded of a product
is to changes in its price
Price Elasticity of Demand Graphically
● PED = infinite,
perfectly elastic
● PED > 1, price
elastic
● PED = 1, unit
elastic
● PED < 1, price
inelastic.
● PED = 0, perfectly
inelastic
Price Elasticity of Demand - Examples

Example

Perfectly Perfectly Unit

Elastic Inelastic
Elastic Inelastic Elastic

Life-Saving Airline
Wheat Salt Apples
Medication Tickets
Factors Influencing Price Elasticity of Demand

Factors

Necessity vs. Luxury Availability of Substitutes Time Horizon

Necessity - Close substitutes - Longer -

Inelastic Elastic Elastic

No close
Shorter -
Luxury - Elastic substitutes -
Inelastic
Inelastic
Ratio Method - PED
● Formula:
PED = (-) (% Change in Quantity Demanded) / (% Change in
Price)

● If the price of a car model increases by 10%, and the quantity demanded
falls by 20%:
PED = (% Change in QD) / (% Change in Price)
=(-20% / 10%)
= -2.0,
Indicating elastic demand
Revenue Method - PED
● Links total revenue and price of a good to determine the elasticity
Price Total Revenue PED
Increases Constant PED = 1
Decreases Constant
Increases Decreases PED > 1
Decreases Increases
Increases Increases PED < 1
Decreases Decreases
Revenue Method – PED Example
• Initial quantity demanded of bread: 1,000 units per month
• Initial price of bread: Rs. 50
• Final quantity demanded of bread: 900 units per month
• Final price of bread: Rs. 60
Then,
Initial revenue = 1000*50 = Rs. 50,000
Final revenue = 900*60 = Rs. 54,000
Thus, PED < 1 implying inelastic demand (PED = -0.5)
Geometric Method - PED
● Involves using a graphical approach to
determine the elasticity of demand at a
specific price point.
● Particularly useful when you have a demand
curve and want to find the elasticity at a
particular price.
● PED = CB (lower segment from C) / CA
(Upper segment from C)
Geometric Method – Linear & Non-Linear Demand Curve
Geometric Method – Linear Demand Curve Elasticities
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Income Elasticity of Demand
Income Elasticity of Demand
● Measures how changes in income affect the quantity demanded of a
good.
● Formula:
YED = (+) (% Change in Quantity Demanded) / (% Change in
Income)
● Categories:
1. Positive YED (Normal Goods: Luxury vs. Necessity)
2. Negative YED (Inferior Goods)
3. Zero YED (Income Irrelevant Goods)
Income Elasticity of Demand Graphically
Income Elasticity of Demand
YED

Positive Negative Zero

Income Irrelevant
Normal Goods Inferior Goods
Goods

Necessity – YED < 1

Luxury – YED > 1

Numerical Example
● Suppose you want to calculate the YED for pizza
• Initial average income of consumers: Rs. 30,000 per month

• Initial quantity demanded of pizza: 10 per month

• Final average income of consumers: Rs. 35,000 per month

• Final quantity demanded of pizza: 12 per month

YED = (% Change in QD) / (% Change in Income)
=(20% / 16.67%)
= 1.20,
Indicating a normal luxury good
Cross Elasticity of Demand
Cross Elasticity of Demand
● Measures how the quantity demanded of one good or service (Good
A) changes in response to a change in the price of another related
good or service (Good B).
● Formula:
XED = (% Change in QDA) / (% Change in PB)
● Categories:
1. Positive XED – Substitute Goods
2. Negative XED – Complementary Goods
3. Zero XED – Unrelated Goods
Cross Price Elasticity of Demand Graphically
Numerical Example
• Initial quantity demanded of coffee: 1,000 cups per month
• Initial price of tea: $2 per box
• Final quantity demanded of coffee: 1,200 cups per month
• Final price of tea: $3 per box
XED = (% Change in QC) / (% Change in PT)
=(20% / 50%)
= 0.4
Indicating substitute goods
Demand Forecasting
Demand Forecasting
● Process used by businesses and organizations to predict future
customer demand for their products or services.
● It involves analysing historical data, market trends and other
relevant factors to make informed estimates about future
demand.
● Effective demand forecasting is crucial for various aspects of
business operations, including inventory management,
production planning and resource allocation.
Demand Forecasting Methods

• Using expert judgment and subjective information

Qualitative Methods • Eg: Delphi method and market research surveys

• Using historical data to make forecasts

Time Series Analysis • Eg: Moving average method

• Identifying cause-and-effect relationships between

Causal Models demand and various factors
• Eg: Regression analysis

• Used to make predictions based on large and

Machine Learning complex datasets
and AI • Eg: Neural networks, machine learning algorithms,
Summary
● Movement along a demand curve occurs due to change in price of
the commodity
● Shift in demand curve occurs due to change in other factors
● Price elasticity of demand shows the responsiveness of quantity
demanded to change in price
● Income elasticity of demand shows the responsiveness of quantity
demanded to change in income
● Cross price elasticity of demand shows the responsiveness of
quantity demanded to change in price of related goods
● Demand forecasting is a process used by businesses and
organizations to predict future customer demand for their goods
Thank you