22

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Demand

The fundamental dictum of the Law of

Demand states that price and quantity
demanded are inversely related.

That is, as price rises (falls), the

quantity demanded for a good or service
decreases (rises), ceteris paribus.
Consider the following figures on the
demand for Valencia oranges in the
Philippines ;
PRICE QUANTITY CONSUMERS ADVERTISING AVE. PRICE OF
(Php/ KG) (KG) INCOME EXPENDITURE APPLES
(PHP) (PHP) (PHP)

5 80000 25000 50000 20

10 70000 25000 50000 20
15 60000 25000 50000 20
20 50000 25000 50000 20
25 40000 25000 50000 20
30 30000 25000 50000 20
35 20000 25000 50000 20
40 10000 25000 50000 20
De mand Is the various quantities of
goods and services that the
consumers are willing to
purchase at a particular price ,
ceteris paribus
Price (pesos/kg)

Demand curve for

oranges

Quantity (kg)

80,000 kg
 m and
e t de
a rk
M
urve
c

A curve indicating the total

quantity of a good all
consumers are willing to and
able to purchase at each
possible price , ceteris paribus
(holding the prices of related
goods, income , advertising
that influences taste &
preferences, and other
Change in demand

Changes in the variables other

than price of a good, such
income or the price of another
good, lead to a change in
demand. This correspond to a
shift of the entire demand
curve.
Change in quantity demanded

Changes in the price of a

good lead to a change in the
quantity demanded of that
good. This corresponds to a
movement along the demand
curve.
Factors Affecting Price
Demand

These are the

shifters of the D-
curve or the factors
affecting the
behavior of the
demand curve other
than price.

The effect of which Quantity

(kg)
will either bring
80,000
about an increase in kg
the total demand
(rightward shift in D-
curve) or will cause a
decrease in demand
(leftward shift in d-
curve).
Income (M)
The effect of income on demand can come in
two different ways;

One is a normal good , where an increase

in income (M) will have a greater than zero
(>0) effect or will result to an increase in the
consumption of that good or service.

The other one is when the good is

inferior, where an increase income will
result to is
Example
Example a the
is less
the than zero
consumption
consumption for (<0)
for corn
corn as
as aaeffect or will
staple.
staple. To some group
group of
of consumers, if
decrease Tothe
someconsumption of
consumers,
their level of income increases,
that good.
if
their level of income increases,
consumption
consumption forfor corn
corn will
will not
not necessarily
necessarily
increase
increase but in fact decreases as
but in fact decreases as some
some ofof
them will shift to rice consumption
them will shift to rice consumption which which
have
have now
now become
become relatively
relatively affordable
affordable as
as
a result of the increase in income.
a result of the increase in income. In In
essence,
essence, corn
corn asas aa staple
staple isis an
an inferior
inferior
good over rice.
good over rice.
Price of related goods (Py)
Effect of this factor comes in two different
aspects;

One is that if a related good is a substitute

in which case if the price of the substitute increases,
the demand for the good under consideration will
increase (the effect is > 0) and vice versa.

The other one is when the related good is a

complement (as in the case of coffee and
sugar), if the price of the complement increases,
the demand for the main product under consideration
will decrease (it will have a < 0 effect in
demand).
Advertising and consumers taste
and preference (A)

The effect for this

particular factor to the
demand of a product is
strictly > 0. Meaning an
increase in ad will induce
an increase in demand.
Population or number of
consumers

The higher the population the

more consumers of the
product, hence demand will
also increase (the effect is
strictly > 0).
Consumer expectation (X)

Again the effect to demand

of this particular factor is
strictly > 0. Increase in
consumer expectation, will
result to an increase in
demand.
Demand Function

Is a function that describes how

much of a good will be purchased at
alternative prices of that good and
related goods, alternative income and
alternative values of other variables
affecting demand.
 Although there are several functional forms of a
demand function, for purposes of simplicity, let us
assume a linear demand function given implicitly
as ;

Qxd = f( Px, Py, M, A, H)

Where:
Px = Price of good X
Py = Price of related good
M = Income
A = taste and preference
H = value of other variables
Explicitly, a linear d-function
could be defined as;

Q d   0   x Px   y Py   m M m   a A   h H  
x

Where:
Px = own price
Py = price of competing goods
Income = Consumers income
A = Taste and preference or Advertisement
H = number of household
Assuming an estimating equation of a linear demand function as;

Qxd = 12000 - 3Px + 4Py - M + 2A

Given that;
Px = P200.00
Py = P15.00
M = P10,000
A = 2000 units

Required:
Qdx = ??
Qxd = 12000 – 3(200) + 4(15) – 1(10000) + 2(2000)
Qdx = 5,460
Qx d … is what we call as the inverse demand curve

Using the above equation, how do we plot the

demand curve of the product?
- the solution
1
3
requires that we let Px be
variable and all others held constant. This
means that rewrite the equation in this manner;
Qxd = 12000 – 3Px + 4(15) – 1(10000) + 2(2000)
Qxd = 6060– 3Px
Or 1 d
P = 2020 - Q x
3
2,020
Consumer Surplus

The utility of this concept to managers is

in its being a useful to show that a
demand curve can be used to ascertain
the value a consumer or group of
consumers receives from a product.

It is also being useful in marketing and

other disciplines that emphasize
strategies such as value pricing and
price discrimination.
Consumers surplus….

…means the value consumers get from

a good but do not have to pay for it.

More generally, consumer surplus is the

area above the price line (price paid for
a good) but below the demand curve.
Imagine that the demand
curve (as shown above )
What is the WTP at;

•First bottle?
•Second bottle?
•Fourth bottle?....why is it
declining?

….each liter of additional

bottle of water, contribute
to an experience that is
approaching saturation
point.

Hence, declining WTP will

be the natural result.
Question! What about if the price of water is at P20/liter? How much is the
total consumer value? And, how much is the consumer surplus?
Solution steps;
a. Compute the total revenue (TR) @ 3 liters
TR = p(Q)
TR = P20.0 (3 liters) = P 60.00

b. compute the consumer surplus (CS) @ 3 liters

P50  P 20
CS  *3
2

CS = P45.00
c. compute the total customer value (WTP) for three liters
WTP = TR + CS = 60 + 45 = P105.00
Supply

Competitive market - There many producers

, each producing a similar product.

The market supply curve- summarizes the

total quantity of goods and services
producers are willing and able to produce
(sell) at alternative prices ceteris paribus.
Change in quantity supplied vs Change in supply:
Change in Q-Supplied vs. Change in Total Supply:

•Itis essentially the effect of

price on the supply all others
factors held constant. The fact
that the market supply curve
is upward sloping reflects the
Law of Supply:
•As the prices of goods rises
(falls) , quantity supplied rises
(falls) ceteris paribus .
Producers are willing to
produce when prices are high
•When other factors change
aside from price, the result
will be s shifting of the entire
supply curve. This is known
as the change in total supply.
Factors Affecting Supply
(supply shifters)

Input prices – This refers to

the prices of factors of
production e.g. variable
and/or fixed factors. Any
change in the prices of these
factors will cause a less than
zero (< 0 ) change in supply.
Technology or government
regulation – The intended effect of
technology would always be either
increase in income or reduce cost of
production. Some examples would
be new products and processes,
environmental compliance
regulation e.g. emission standards
etc. Any change in these factors
would result to a > 0 effect on total
supply or will shift the supply curve
to the right.
Number of producers or
firms – Obviously, as when
there are many producers (as
affected by entry and exit
barriers in the industry) more
of the goods can be produced.
Hence, the effect will always
be > 0 on the total supply.
Substitutes in production –
Example is; pulp processing using
pine wood . When prices of wood
pulp increases due to the
international campaign to protect
global forest cover coupled with the
strong global advocacy to use
natural instead of synthetic fibers,
processors shift from using wood to
abaca as source of pulp raw mat
(RM). The effect will result to a < 0
effect on total supply of pinewood.
Taxes – The effect of taxes on
total supply will come in two
forms; one is an excise tax
and Ad valorem tax;
Excise tax - is a tax on each
unit of output sold and the
tax revenue is collected from
the supplier. In effect, an
excise tax shifts the supply
curve up by the amount tax
(figure A). Has the effect of
reducing supply in the
 Price

S+t

P+t
t = 0.75

0 Quantity Supplied

Figure A. Effect of excise tax on total supply

 Another form of tax often use
by the government agency is
ad valorem tax. Ad valorem
literally means based on value.
This is a percentage tax; the
sales tax or even VAT are
common examples. Since this
ad valorem is based on value,
the tax imposition is higher in
high value (high-priced) items
(Figure B).
 Price

S+t

t1’’

to’’

t1’

to’

0 Quantity Supplied
q’ q’’

Figure B. Effect of Ad Valorem tax on total supply

 Producer expectations - If
the firm suddenly expects
prices to higher in the future
and the product is not
perishable, producer can hold
back output today and sell it
later in the future for a higher
price. The effect is shifting the
supply curve to the left
( < 0 effect ).
Supply Function

Supply Function - describes how

much of a good will be produced at
alternative prices of that good,
alternative input prices, and
alternative values of other variables
affecting supply.

Supply function can be given as;

Qdx = f (Px, Pr, W, H)
Using a linear supply function, the following
equation can be formulated;

Q d x   0   x Px   r Pr   wW   h H  

Where:
Qdx = quantity supplied of a good
Px = price of the good
Pr = price of the technologically related goods
W = price of an input
H = value of some other variables affecting supply
 Assuming that from the research
department estimate of the supply equation is
given by;

Qdx = 2000 + 3Px - 4Pr - Pw

Suppose ; Px = P400
Pr = P100
Pw = P 2000

The equation becomes ;

Qdx = 2000 + 3(400) – (4)100 – 1(2000)

Plotting of the inverse supply function given that
•Qdx = 800

The plotting would be….

Qdx = 2000 + 3Px – (4)100 – 1(2000)
Qdx = 2000 + 3Px – 2400
Qdx = 3Px – 400 alternatively, Px = 400 + 1 Qd
x
3 3
Price

Producer surplus
Qdx

A B
400

133.33
C

Quantity
0A 800
Producer Surplus

Formally, producer surplus is the

amount producers receive in
excess of the amount necessary
to induce them to produce the
good. This is the area above the
supply curve but below the price
line.
Producer Surplus

Price

Producer surplus

A B
400

133.33
C

Quantity
0A 800
Market Equilibrium

•The equilibrium price in a competitive

market is determined by the interactions
of all buyers and sellers in the market or
the interactions of the market supply
and market demand for a good. reason

Why market always clear or

settle at the equilibrium point??
Price

F G
Ph
surplus

Pe

shortage
Pl
A B

D
O Quantity
Qo Qe Q1
Figure . Market equilibrium
Price Ceilings and Floors

Price ceilings - The market system uses

price to determine who gets the good and
who does not. Sad to note that not all
consumers are able to pay the price of a
scarce resource or good, hence, it is
incorrect to say that the price system is
unfair. Any method of allocation for that
matter, would seemingly be unfair to
someone because there are just not
enough of a good for everybody.
Price The area bounded by AFC is lost
producer and consumer surplus
due to a price ceiling S

F
PF
surplus

Pe
C

shortage

Pc
A B

D
O Quantity
Qo Qe Q1

Figure A. Price ceiling diagram

How then can the goods be allocated??

…. Rationed on the basis of “first come first

served”

Hence, buying the good at the ceiling price

will involve the incurrence of an economic
price.. which is theoretically computed as;

PF = Pc + ( PF – PC)
Where:
PF = full economic price
Pc = celing price
Pe = equilibrium price
Price The area bounded by AFC is lost
producer and consumer surplus due to
a price ceiling S

F
P F

surplus

Pe C

shortage

Pc B
A

D
O Quantity
Qo Qe Q1

Figure A. Price ceiling diagram

Price floors - In contrast to the
case of price ceiling, sometimes the
equilibrium competitive price maybe
considered too low for producers. In
this instance the individual producers
may lobby for the government to
legislate a minimum legal price for a
good. Such price is called a price
floor. Perhaps the best known
example is in the case of a legislated
minimum wage, which is the
minimum allowable wage that should
be paid to workers.
Price

F G
Pf
surplus

The cost of purchasing excess

P e supply
C

A B

D
O Quantity
Qd Qe Qs

Figure B. Price floor diagram

 Elasticity Concept
Elasticity of demand can be used to quantify the impact
of changing market conditions on the firm’s sales.

Formally, elasticity measures the responsiveness of one

variable to a change in another variable.

In this context, the elasticity enrollment with respect to

tuition fees charges can be denoted by EE,s is the
percentage of change in enrollment (%E) that will result
from a given percentage change in tuition fees per
semester (%T). In other words,

%E
EE,s =
%T
Alternatively, the formula can be
written formally in calculus
notation as ;

dE T
EE,s = dT * E
There are two aspects of an
elasticity that are important:

•(1) whether it is positive or

negative, and

•(2) whether it is greater than 1 or

less than 1 in absolute value.
Own Price Elasticity of Demand

•Formally,own price elasticity is the measure

of the responsiveness of quantity demanded
to a change in price (own price). This is a
useful tool in measuring the quantitative
impact of price hikes or cuts on the firm’s
sales and revenues. This is given by the
formula as;
%Qx
EQx, Px =
%Px
• Alternatively, if the demand
function is; Qdx = f(Px, Py, M, H)
the own price elasticity of demand
can be written as;
Qx Px
EQx, Px = *
Px Qx

Where;
EQx, Px = Own price elasticity of demand
Qx = quantity demanded of good –x
Px = own price of good – x
• Recall that two important aspects of
elasticity of demand: (1) its sign, and
(2) whether its greater than or less
than 1 in its absolute value.

•By argument of the law of demand,

there is an inverse relation between
price and quantity demanded; thus the
own price elasticity of demand is a
negative number. Thus its absolute
value can be > or 1> depending on
several factors affecting it.
Three type of own price elasticity;

Eqx, px  1 ….. elastic demand - if the absolute value of the

own price elasticity is greater than 1

Eqx, px  1 …….. inelastic demand – if the absolute value of the

own price elasticity is less than 1

Eqx, px  1 …….. unitary elastic demand - if the absolute value

of the own price elasticity is equal than 1
Elasticity and Total Revenue

Given that the demand function is written as;

Qdx = 80 – 2Px

and total revenue (TR) is given as

TR = Px(Qx)

Using the above equations, you will notice

that the absolute value of the own price elasticity
gets larger as price increases.
Table . Total revenue and elasticity of Marikina-made ladies shoes

PRICE QUANTITY SOLD OWN PRICE TOTAL REVENUE

ELASTICITY
(PhP/pair) (pairs) ( Eqx, px) (Px *Qx)

0 80000 0.00 0
215 70000 - 0.14 15,050,000
430 60000 - 0.33 25,800,000
645 50000 - 0.60 32,250,000
860 40000 - 1.00 34,400,000
1075 30000 - 1.67 32,250,000
1290 20000 - 3.00 25,800,000
1505 10000 - 7.00 15,050,000
1720 0 (infinity) -
Graphically, the total revenue test can be illustrated as;

PhP/pair

1720

Eqx, px = - 7.00 (elastic)

1505

860 Eqx, px = 1.00 (unitary)

215
Eqx, px = - 0.14 (inelastic)

0 Q (pairs)
40K 70K 80K

Figure . Demand, elasticity and total revenue

Principle: (Total Revenue Test)

• If the demand is elastic, an increase

(decrease) in price will lead to a
decrease (increase) in total revenue.
If the demand is inelastic, an increase
(decrease) in price will lead to an
increase (decrease) in total revenue.
Finally, total revenue is maximized at
the point where demand is unitary
elastic.
Insights :
• If used as a competitive pricing
strategy, it would be helpful to
know the demand function of the
product. If estimation of the
correct demand function is not
available, know the approximate
position of your product price
along the demand curve. How??
The simplistic way to do it is to
compare your price with your
competitor selling the same
Factors Affecting Own Price Ed

Available substitutes – when there are

few close substitutes for a good, demand
tends to be relatively inelastic. This is
because consumers can not readily switch to
a close substitute when price increases. A
key implication of the effect of the number of
substitutes on the elasticity of demand is that
the demand for broadly defined commodities
tends to be more inelastic than the demand for
specific commodities
Factors …

Time – demand would 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.
Expenditure share – Goods that comprise a
small share of consumers’ budget tend to be
more inelastic than goods for which
consumers spent a sizeable share of their
income. A little change in price would
already be a significant impact on consumer
spending if the good absorbs a sizeable
share of their income. Hence, elasticity of
demand will be more elastic.
Cross Price elasticity

Formally, cross price elasticity is a measure of

the responsiveness of the demand for a good
to changes in the price of a related good; the
percentage in the quantity demanded of one
good divided by the percentage change in the
price of a related good.

Denoted EQxy, Py, mathematically as;

%Qxd
EQxy, Py = %Py
Income Elasticity
Income elasticity is a measure of the responsiveness of
consumer demand to changes in income. Mathematically,
income elasticity if demand is defined as;

%Qxd
EQx, M =
%M
Or alternatively as,

Qx M
EQx, M = *
M Qx
Long quiz!!
1. What is the difference between economic and
accounting profit? Give example if possible to
stress your point.
2. In your own understanding, explain the concept of
Time Value of Money.
3. What is the difference between “consumers’
surplus and producers’ surplus? Illustrate and
discuss. How can you apply this concept in
marketing?
4. Differentiate the effect of excise tax from ad
valorem tax policy in regulating the supply and
demand of a particular product. Provide illustration
or example to explain your answer.
5. If the good is inferior, the marginal effect of income
on demand is less than zero (ceteris paribus) .
Why?