Managerial Economics

Demand :

Desire +
Ability to pay +
Willingness to spend

Eg. Buying a Car ,

Owning a flat,
Going to Goa,etc..
DETERMINANTS OF DEMAND

1. Price of the Product. : The price of commodity or services directly

affects its demand. The fall in the price of a commodity leads to rise in its
demand and rise in price leads to fall in its demand..

Eg, Redmi Note 7, GST on food items at resto, pulses like beans,etc.

2. Price of Related Goods. :

Eg. Substitute Goods : The rise in the price of Cocacola increases demand for
Pepsi and vice-versa, tea or coffee, mirinda and fanta.

Complementary goods :
Complementary goods are those which, are jointly demanded to satisfy a particular
demand.
E.g. A fall in the price of Car will lead to increase in the demand for petrol.
Eg. Shoe and polish.
Samosa and potato.
Computer hardware and computer software.
Printer and ink cartridges.
Pencils and erasers.
3. Level of Income. :

There is a direct relationship between income and quantity

demanded.
Rich consumers usually demand more and more goods than the
poor customers.
Demand for luxury and expensive goods are related to the income.

Eg. UAE people.

4. Taste, Habits and preferences of Consumer. :

Demand for goods changes with change in fashion, habits, customs,

traditions and general life-style of the society.
Demand for several products like ice-cream, chocolates etc. depends on taste
and demand for tea, cigarettes, tobacco is a matter of habits.
5. Future trend of Prices. If it is expected that in future the price of a commodity
will go up the demand for the commodity in the present also will go up.
Eg. Share prices.

6. Changes in Population. Generally the demand for a commodity increases

with increase in size of population, other things being equal.

In a country of increasing population like India where hundreds of children

are born daily in big cities there will naturally be demand for toys, baby food and alike.

7. State/status of Businesses in the country : If the country is passing through

prosperity and boom conditions, there will be a marked increase in demand.
8. Distribution of Income and Wealth. If the distribution of
income is equal then the demand for all normal goods will be
more. eg Developed Countries.

9. Availability of Consumer Credit. If the credit facilities are

available sufficiently to consumers for the purchase of high priced
durable goods such as car, color TV, scooters and alike, then their
demand will increase.

10. Advertisement and Salesmanship. In the modern market,

advertisement greatly influence the demand for a commodity.
In fact, the demand for many products like to toothpaste,
Cosmetics etc. is greatly affected by advertisement.
11. Climate and weather conditions.

Demand for certain products is determined by climatic and weather conditions for
example, in summers there is a great demand for cold drinks, fans, air conditioners
etc.

12.Fashions.

The demand for many products is affected by changing fashions. For example demand
for jeans is based on current fashions . Low waist jeans , high waist jeans.

13.Festive, Customs.

Demand for certain goods is determined by social customs, festivals etc., for example,
during the Diwali days there is a great demand for sweets & during Christmas cake are
more in demand.
Law of Demand :
Describes the general tendency of consumers behavior

Expresses the relationship between price and quantity demanded of a commodity.

Statement : Other things remaining the same, the higher the price of a commodity,
the smaller is the quantity demanded and lower the price, larger the quantity
demanded”.

Other things include;

Income of consumers,
Prices of related goods,
Population ,
Amount of money in circulation (Money Supply), etc.
Chief Characteristics of the Law of Demand

1. Inverse Relationship.

2. Price an Independent Variable and Demand a Dependent Variable.

3. Other thing remains the same.

Price of Commodity ‘X’ (in Rs.) Quantity Demanded of ‘X’
(in kgs.)
5 10
4 20
3 30
2 40
1 50
ASSUMPTIONS OF THE LAW OF DEMAND:

No change in taste, habits, preferences

No change in the income level

No change in population

No change in prices of related goods

No expectation of future change in the price

No change in taxation

No introduction of new product

No change in technology

No change in weather conditions

EXCEPTIONS TO THE LAW OF DEMAND

1. Articles of Distinction/prestigious goods (Conspicuous Consumption):

The articles of distinction such as diamonds, gems, costly carpets, etc. are
in more demand when their prices are high.

2. Giffen Goods (Staple/Routine items ) (Giffen Paradox)

Sir Robert Giffen has given this paradox in 19th century when he studied the
consumption pattern of workers in Britain.

Bread and Meat prices in Britain. With increase in prices of bread ,

the demand also got increased.

3. Necessities of Life. We cannot reduce the consumption of necessaries of

life and conventional necessaries even if their prices have increased sharply.
Eg . Salt, Onion, milk, etc.
4. Good quality products /quality preference comes first : people are to demand
even more at a higher price provided quality is good. Apple Iphone, Samsung s9
plus.

5. Fashionable goods. Goods that are in fashion are purchased by consumers

regardless of price even at a higher price. Consumers purchase the goods which are
in fashion.

Eg. Levis Jeans, cotton jeans, rayban , etc

1. Law of Diminishing Marginal Utility.

The utility of an additional unit of a commodity is the Marginal Utility (MU). Utility is
the basis of demand.

Law of diminishing marginal utility states that marginal utility of a commodity

diminishes when a consumer takes successive units of a commodity.
Cups of Tea Total Marginal Price per
Utility utility cup
(MUx) Px
Consumed (units) (units)
per day
1 25 25 5
2 45 20 5

3 60 15 5

4 70 10 5

5 75 5 5
6 70 -5 5

7 60 -10 5

8 45 -15 5
2. Income Effect.

As the price of a commodity falls, the real income or purchasing power

of the buyer increases because he can purchase the same quantity of the commodity
with lesser amount of money at a lower price.

A part of the increase in his real income may be used to purchase more of the
cheaper commodity while remaining part may be spend on other goods.

This is the income effect of fall in price. Therefore, when price falls, the quantity
demanded increases due to increased real income and vice-versa.
Demand Function

A demand function in its mathematical terms expresses the functional

Relationship between the demand for the product and its various determining
Variables.

Dx = f ( Px, Ps,Pc,Yd,T,A,N.u)

Where Px is the own price of the product,

Ps :price of the substitute goods
Pc : price of the complementary goods
Yd : level of income with the buyers
T : change in buyers tastes and preferences
A : advertisement effect
N : changes in population
U : is the unknown determinants
Dx : amount demanded.
In economic theory , however a very simple statement of demand function is
Adopted, assigning all other determining variables, except the own price of the
Product, to be constant.

An over simplified and the most commonly stated demand function is thus :

Dx = f (Px)
Demand equation and demand schedule

A linear demand function may be stated as follows :

D=a -bP

where
D is the amount demanded,
a is a constant parameter signifying initial demand irrespective of the price.
b is a constant parameter which represents functional relationship between
Price P and the demand D.
b’s negative sign indicates negative function indicating downward slope.
Illustration no 1 :

Estimated demand equation is given as Dx= 20 – 2Px.

Draw demand curve it prices per unit of a commodity are rs. 1,2,3,4,5 respectively.
Illustration no 2 : market demand function are illustrated as follows :

2. The demand function for cigar packs in a city is Dx= 400 – 4 p.

Where Dx = Quantity demanded of cigar ( in ‘000 cigars per week )

P= Price of a cigar pack.

a. Construct a demand curve assuming price rs. 10,12,15,20 and 25 per pack.
b. At what price would demand be zero.
c. If the producer want to sell 3,80,000 packs per week ,what price should it charge ?
Illustration No 3 : Sachin and Tendulkar’s stated the following demand function for a brand
X of batting equipments :

Dx = f ( Px, Pz, Nw, Y, A)

Where Dx = quantity demanded per year for brand X of batting equipments in a city.
Px = price of X brand
Pz = price of Z brand
Nw = Number of working women
y = mean annual household income
A = annual advertising expenditure.
Assuming hypothetical data, we may state the demand estimation as under :

Dx = 11,93,200 - 100 Px + 20 Pz + 0.002Nw + 1.8 Y + 0.3 A

On this basis, given that
P x = 8,000, Pz = 9,000 , Nw = 8,00,000 in a city , Y= 1,00,000 rs, A= 60,000.
Illustration no 4 : Gully boy and the co, the computer maker , has estimated the following
Demand function for the steel cabinets produced by them :

Dx = 1500 - 0.03 P + 0.09 AE

Where Dx = Quantity demanded of steel cabinets

P = Average price of steel cabinets
AE= the firm’s Advertising expenditure.
All data are on quarterly basis. The firm currently spends rs. 10,000 per quarter on advertising.

State the demand curve equation for the price –demand relationship. Give graphical
Representation assuming price variable values to be rs, 10k,9k,8k,7k and 6k.

Note : plot price and quantity values on a graph.

Law of supply
 There is a direct relationship between the price of a commodity and
its quantity supplied.

As the price of a commodity increases there is an increase in the quantity supplied

Keeping other things constant.

Supply function
The supply function is now explained with the help of a schedule and a curve.

Market supply schedule of a commodity

Px 4 3 2 1
Ds 100 80 60 40

Graph
Formula for law of supply /Supply function

The supply function is expressed as

Ds= f ( Px, Tech, Si, Fn, X…)

Here
Ds = quantity supplied of a commodity X by producers.
F = function of
Px = price of commodity X,
Tech = Technology
S =Supplies of inputs
F= Features of nature
X= taxes/subsidies .
ELASTICITY OF DEMAND
The law of demand which explains the “direction of change” in the quantity
demanded due to a given change in price.

The law, however, does not measure the rate of change or degree of change.

(Rate of change : means how much Y changes when X changes by small

amount)

In case of salt the rate of change in quantity demanded may be negligible in

relation to a change in its price, while in case of an expensive car the rate of
change in quantity demanded may be very large.

Elasticity of demand measures the rate of change in the quantity demanded

due to a given change in any of the determinants of demand such as price of
the commodity, price of related goods, money income of consumers,
advertisement tastes, etc.
Elasticity is thus a technical term that is used by the economists to describe the
degree of sensitiveness (or responsiveness) of the demand for a commodity to a
fall in its price.

Marshall's concept of elasticity may be referred to as 'price elasticity' as he used

this concept only with reference to price changes. However, today, economists
have extended the application of the concept of elasticity to several other variables.
TYPES OF ELASTICITY OF DEMAND

Price-elasticity of demand: Price-elasticity of demand is the degree of

responsiveness of the demand for a commodity due to a change in the price.

Ed or Ep = Proportionate change in quantity demanded

Proportionate change in price

Income-elasticity of demand: It is the response of change in demand due to the

change in the income of an individual.
Income-elasticity of demand may be defined as the responsiveness of
demand for commodity to the changes in income, other determinants remains
constant.

Ey= Proportionate change in quantity demanded

Proportionate change in income
 Cross-elasticity of demand: It is the response of change in demand for 'X’ good
(tea) due to the change in the price of 'Y' good (coffee).

Ec = Proportionate change in quantity demanded of commodity ‘X’

Proportionate change in price of commodity Y
Measurement of Elasticity of Demand.

The numerical coefficient ranges from zero to infinity. Thus, now let us understand
the different methods to measure the 'exact' change in quantity demanded to the
change in price.
From practical point of view, it is not enough to know whether the demand for a
commodity is elastic or inelastic. The concept becomes more fruit-bearing, if it can
also suggest the exact numerical change in demand corresponding to price. For this
purpose it is necessary for us to measure' elasticity of demand.

I. Ratio or Proportionate of Point Elasticity Method

II. Arc Elasticity Method
III. Total Expenditure Method.
IV. Geometrical Method
I. Ratio or Proportion Method: The price elasticity of demand according to this
method can be measured by dividing the percentage change in the quantity
demanded by percentage change in price. The formula used for the measurement
of elasticity is as follows :

Price elasticity of demand = % or proportionate change in demand

% or proportionate change in price

This method is used when % change in price is less than 5% and original price is
known.
 With the help of the following example the ratio method can be explained:

Price Demand
Original 20 100
New 21 96

Q P Q1 – Q P
Ep = --- X --- = -------------- X ---
P Q P1 – P Q

50 -40 10 10 10
100
Ep = ----------- X --- = ----- X -----
= ----
11 – 10 50 1 50 50
Ep = 2

As the numerical value of elasticity of demand is greater than one, the demand
is relatively elastic or more elastic.
DEGREES OF PRICE ELASTICITY OF DEMAND

1.Perfectly Inelastic Demand : (Ep = 0)

With change in price, there is no change in demand

2.Relatively /less elastic demand : ( Ep < 1)

With more change in price, there is just a slight change in demand

3.Uniteray Elastic Demand (Ep = 1)

With a proportionate change in price, there is proportionate change in demand

4.More elastic demand (Ep > 1)

With a less change in price , there is a significant change in quantity demanded.

5.Perfectly elastic demand (Ep = infinite)

With a very minute change in price, there is unlimited increase in quantity demanded.