DEMAND ANALYSIS

DIOVIE T. CABENTA
BSA 1-3
 UTILITY THEORY
 The ability of goods and services to satisfy
consumer wants is the basis for consumer
demand.
 It is a theory postulated in economics to explain
behavior of individuals based on the premise
people can consistently rank order their choices
depending upon their preferences.
 CONSUMER BEHAVIOR THEORY – THREE
BASIC ASSUMPTIONS
1. More is Better – consumer always prefer more to less of
any good or service. Economists refer to this as the
nonsatiation principle.
2. Preferences are complete – when preferences are
complete, consumers are able to compare and rank the
benefits tied go consumption.
3. Preference are transitive – when preferences are
transitive, the consumers are able to rank order the
desirability of various goods and services.
 • Is a descriptive statement that
relates satisfaction or well-being
to the consumption of goods and
UTILITY services.
FUNCTIONS
• Utility = f(Goods,Services)
MARGINAL UTILITY

• Total utility measures the consumer’s

overall level of satisfaction derived from
consumption activities, marginal utility
measures the added satisfaction derived from a
1-unit increase in consumption of a particular
good or service, holding consumption of other
goods and services.
LAW OF DIMINISHING
MARGINAL UTILITY

• The law of marginal utility

states that as an individual
increases consumption of a
given product within a set of
period of time, the marginal
utility gained from consumption
eventually declines. This law
gives rise to a downward-sloping
demand curve for all goods and
services.
# OF SCOOPS OF ICE TOTAL UTILITY MARGINAL UTILITY
CREAM
1 3 3
2 5 2
3 6 1
4 7 1
5 5 -2
 LAW OF DIMINISHING MARGINAL UTILITY

0
TOTAL UTILITY MARGINAL UTILITY
5 4 3 2 1
 INDIFFERENCE CURVE
Represent all market basket that provide a given consumer the
same level of utility or satisfaction.

Basic Characteristics
1) Higher indifference curves
are better – consumers prefer
more to less, so they prefer
higher indifference curves that
represent greater combinations
of goods and services.
• 2) Indifference curves do not intersect – holding
goods constant, an indifference curve involving a
greater amount of services must give greater
satisfaction. Holding services constant, an
indifference curve involving a greater amount of
goods must give greater satisfaction. This stems from
the fact that goods and services both provide
consumer benefits, and reflect the “more is better”
principle. If indifference curves crossed, this principle
would be violated.
• 3) Indifference curves slope downward –
the slope of an indifference curve shows
the trade-off involved between goods and
services. Because consumers like both
goods and services, if the quantity of one
is reduced, the quantity of the other
must increase to maintain the same
degree of utility. As a result, indifference
curves have negative slopes.
4) Indifference curves bend inward (are
convex to the origin) – the slope of an
indifference curve shows the rate at
which consumers are willing to trade-
off goods and services. When goods are
relatively scares, the law of diminishing
marginal utility means that the added
value of another unit of goods will be
small in relation to the added value of
another unit of services. This gives
indifference curves a bowed inward, or
concave to the origin, appearance.
 COMBINATION FAR 0 SLEEP
EXAMPLE
A 1 8
A.FAR O
B.SLEEP B 2 6

C 3 4
 SLEEP

EXAMPLE 7

A.FAR 0 6

5
B.SLEEP 4

1 2 3 4 5 6 7 8 9 10 FAR 0
 The demand curve for an
individual consumer depends
Individual Demand upon the size of the
consumer’s budget
consumption preferences.

Price-consumption Market baskets that

maximize utility at different
Curve prices for a given item.

Income- Utility-maximizing
combinations of goods and
consumption Curve services at every income
level.

A plot of the relationship

Engle Curves between income and the
quantity consumed of a good
or service.
 Given consumer
preferences and
Optimal budget constraint
information, it is
Consumption possible to
determine optimal
consumption.

Measures additional
Marginal Utility satisfaction from an
additional unit of
good.

Assumes consumers
wish to maximize
their utility through
Consumer Choice the optimal
combinations of
goods – given their
limited budget.
Marginal Rate of Substitution
Is the amount of a good that a
consumer is willing to give up for
another good, as long as the new
good is equally satisfying. It’s
used in indifference theory to
analyze consumer behavior. The
marginal rate of substitution is
calculated between two goods
placed on an indifference curve,
displaying a frontier of equal
utility for each combination of
“good A” and “good B”.
 When making purchase
decision, a consumer
attempts to get the greatest
value possible from
expenditure of least amount
of money. His or her objective
is to maximize the total value
derived from the available
money.
UTILITY
MAXIMIZATION
 DEMAND  Demand analysis focuses on
SENSITIVITY measuring the sensitivity of
ANALYSIS: demand to changes in
ELASTICITY range of important factors.
 Elasticity
concept
Elasticity=
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑌
Elasticity is a measurement of responsiveness
used in demand analysis. It is defined as a 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑋
percentage change in a dependent variable Y,
resulting from a percentage change in the
value of an independent variable, X.
The concept of Elasticity simply
involves the percentage change in one
variable associated with a given
percentage change in another variable.

Factors such as price, product quality,

and advertising that are within the
control of the firm are endogenous
variables.

Factors outside the control of the firm,

such as consumer incomes, competitor
prices, and the weather are exogenous
variables.
 POINT
ELASTICITY
Percentage change in Y
Point Elasticity = ɛᵪ =
Small Percentage in X
Measures elasticity at a given point on a
function. It is used to measure the effect
on the dependent variable, Y, of a very
small or marginal change in an
independent variable, X.
 ARC
ELASTICITY
It is a formula that was
developed to calculate an
average elasticity over a given
range.
PRICE ELASTICITY FORMULA

 Measures the responsiveness of the

quantity demanded to changes in price
of the product itself, holding constant
the values of all other variables in the
demand function.
 PRICE ELASTICITY AND TOTAL REVENUE

Depending on the degree of the elasticity, a

reduction in price can increase, decrease, or
leave unchanged the total revenue. A good
estimate of price elasticity makes it possible to
accurately estimate the effect of price changes on
total revenue.
 • Price Elasticity is a measure of
the relationship between a
change in the quantity
demanded of a particular
PRICE good and a change in its
price. Price Elasticity of
ELASTICITY Demand (PED) is a term used
AND PRICE in economics when discussing
CHANGES price sensitivity. The formula
for calculating price elasticity
of demand is:
If a small change in price is
accompanied by a large change in
quantity demanded, the product
is said to be elastic (or responsive Price Elasticity of Demand = %
to price changes). On the other change in Quantity Demanded
hand, a product is deemed / % Change in Price
inelastic if a large change in price
is accompanied by a small amount
of change in quantity demanded.
Is used to examine the responsiveness of
demand for one product to changes in the
price of another.
Isused to examine the
responsiveness of demand for one
product to changes in the price of
another.
Income elasticity of demand

For many goods, income is an important determinant of

demand.
 Demand
Estimation
Chapter 5
 Demand Estimation

Is a process that involves coming

up with an estimation of the
amount of demand for product or
service.
 Interview and Experimental
Methods

Consumer Interviews(Survey)
Questioning customers to estimate demand relations.

Market Experiments
Demand estimation in a controlled environment.
Simple Demand Curve Estimation

• The demand curve shows the link that exists

between a product’s price and how much of
that product people are willing to buy.
• Simple linear relations are useful for demand
estimation.

𝑷 = 𝒂 + 𝒃𝑸
 Example:

The Portland Sea Dogs are the affiliate of the

Boston Red Sox major league baseball team.
Suppose the club offered 25php off the 200php
regular price of reserved seats, and sales spurted
from 3,200 to 4,000 seats per game.
Using Simple Linear Demand Curves

TR = P X Q
 Market Demand Curve Estimation

The market demand curve is the

summation of all the individual demand
curves in a given market.
Graphing the Market Demand Curve
Regression Analysis

Regression analysis is used to study the

relationship between two or more variables.
Moreover, the regression technique is used to
observe changes in the dependent variable with
changes in the independent variables.
Elasticity
Diovie T. Cabenta
BSA 1-3
 ELASTICITY

How sensitive are consumers to a change

in price?
How much less will they buy if prices are
raised?
How much more will they buy more if
they prices are lowered?
WHAT HAPPENS TO
REVENUE WHEN PRICES
HAS CHANGED?
 INELASTIC

Rigid
Not Flexible
Limited Choices
 ELASTIC

Flexibility
Can easily change
A lot of choices
 Inelastic demand and revenue

 InelasticDemand. There is a positive

relationship between price and total
revenue.
 An increase in price increases total
revenue.
 A decrease in price decreases total
revenue.
 Elastic Price and revenue

 ElasticDemand. There is a negative

relationship between price and total
revenue.
 An increase in price decreases total
revenue.
 A decrease in price inreases total
revenue.
prices fall, revenue and elasticity

PRICES REVENUE
GO DOWN GOES UP ELASTIC
GO DOWN GOES DOWN INELASTIC
GO DOWN NO CHANGE UNITARY

PRICES REVENUE
GO UP GOES DOWN ELASTIC
GO UP GOES UP INELASTIC
GO UP NO CHANGE UNITARY
ed  % D Qd
%DP
Example:

Fortune Targets Teen Smoking

10 percent increase in
cigarette prices will lead to a 7
percent drop in youth smoking.
 This means that for every 10% increase in
prices causes 7% decrease in youth smoking….
ed  .07
.10
ed  .07
Types of elasticity
Numerical Value Type Description
Ed > 1 Elastic %∆P > %∆D
Ed < 1 Inelastic %∆P < %∆D
Ed = 1 Unitary %∆P = %∆D
Ed = 0 Perfectly Elastic Same demand at all prices.
Ed = ∞ Perfect Inelastic Infinite demand at same price.
 Point
elasticity
PED  Lower segment
Upper segment
Assume that we will
get the elasticity of
point d.

PED  Lower segment

Upper segment

PED  20
40

PED  1
2

PED  0.5
Assume that we will
get the elasticity of
point c.

PED  Lower segment

Upper segment

PED  40
20

PED 
2
e=∞
e>1
e=1
e<1

e=0
Arc elasticity
6

 ∆q – Change in quantity
 ∆p – Change in price
 P1 + P2 – Initial Price + New 2 4
Price
 Q1 + Q2 – Initial Quantity + New
Quantity
Arc elasticity
Ed  2-4 6+ 2
6
x
6-2 2+4
2
Ed  -2 8
x
4 6

Ed  -16 -2
=
24 3 2 4

|Ed| = 2/3 < 1

Inelastic