02 - DEMAND AND UTILITY ANALYSIS

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DEMAND AND UTILITYDEMAND AND UTILITYANALYSISANALYSIS

Presented ByPresented By

Dr. S P DasDr. S P Das

PhD. (Economics), M.Phil. (Economics),PhD. (Economics), M.Phil. (Economics),M.B.A. (Finance), M.A. (Economics),M.B.A. (Finance), M.A. (Economics),

PGDM, PGDFM, DHMCT, MCCP, B.Com.,PGDM, PGDFM, DHMCT, MCCP, B.Com.,

UGC-SETUGC-SET


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Concept of DemandConcept of Demand Demand means effective desireDemand means effective desire

Effective desire = desire + willingness toEffective desire = desire + willingness topay + ability to paypay + ability to pay

Without willingness and ability to payWithout willingness and ability to pay

desire cant be effective demanddesire cant be effective demand

Demand for a product is the desire for thatDemand for a product is the desire for that

product backed by willingness as well asproduct backed by willingness as well as

ability to pay for it.ability to pay for it.

It is always defined with reference to aIt is always defined with reference to aparticular time, place, price and givenparticular time, place, price and given

values of other variables on which itvalues of other variables on which it

depends.depends.


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Significance of DemandSignificance of Demand Crucial requirements for the functioning of any

business enterprise, its survival and growth. Information on the size and type of demand

helps management in planning its requirementsof men, materials, machines, and money.

Demand analysis seeks to identify and measurethe forces that determine sales; it reflects themarket conditions for the firms product.

Once the demand analysis is done, the

alternative ways of creating, controlling ormanaging demand can be inferred.


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Demand FunctionDemand Function

Demand function is a comprehensiveformulation which specifies the factorsthat influence the demand for theproduct. What can be those factors

which affect the demand? Dx = D (PX, PR, Y, W, A, E, T, M) In other words, a generalized demand

function is a multivariate function

whereas the demand curve is a singlevariable demand function.


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Determinants of DemandDeterminants of Demand

Price of the product (PPrice of the product (PXX)) Price of related goods (PPrice of related goods (PRR))

Income of the consumers (Y)Income of the consumers (Y)

Wealth of a Consumer (W)Wealth of a Consumer (W)Tastes preferences of the consumer (T)Tastes preferences of the consumer (T)

Advertisement for the product (A)Advertisement for the product (A)

Price expectation of the user (E)Price expectation of the user (E) Other factors (M)Other factors (M)


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Types of DemandTypes of Demand

1.1. Direct and derived demandDirect and derived demand

2.2. Domestic and industrial demandDomestic and industrial demand

3.3. Autonomous and induced demandAutonomous and induced demand

4.4. Perishable and durable goodsPerishable and durable goods

demanddemand

5.5. New and replacement demandNew and replacement demand

6.6.

Final and Intermediate demandFinal and Intermediate demand

7.7. Individual and market demandIndividual and market demand

8.8. Short run and long run demandShort run and long run demand


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Law of DemandLaw of Demand The law of demand states that Ceteris

paribus (other things remaining the same),higher the price, lower the demand and viceversa. The law is stated primarily in termsof the price and quantity relationship. The

quantity demanded is inversely related toits price. Here we consider only two factors i.e. price

and quantity demanded.

All the other factors are assumed to beconstant.


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Assumptions of Law of DemandAssumptions of Law of Demand

Income of the consumer is constant. There is no change in the availability and the

price of the related commodities (i.e.complimentary and substitutes)

There are no expectations of the consumersabout changes in the future price andincome.

Consumers taste and preferences remain the

same. There is no change in the population and its

structure.


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Demand ScheduleDemand Schedule

Its a tabular representation of theIts a tabular representation of theprice and the quantity demanded.price and the quantity demanded.

It tells us the relation between theIt tells us the relation between the

price of the product and the quantityprice of the product and the quantity

demandeddemanded

TypesTypes::

Individual demand scheduleIndividual demand schedule Market demand scheduleMarket demand schedule


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Demand Schedule & DemandDemand Schedule & Demand

CurveCurve

Price (Rs.)Price (Rs.) QuantityQuantity

9090 4040

7070 120120

5050 200200

3030 280280

1010 360360


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Market Demand ScheduleMarket Demand Schedule


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Market Demand CurveMarket Demand Curve


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Equation & SlopeEquation & Slope

Qx = Q(Px) In the slope - intercept form, the demand

curve which may be stated as

DX = + PX, where is the intercept term

and the slope which is negative because ofinverse relationship between DX and PX.

Suppose, = (-) 0.5, and = 10

Then the demand function is : PX

=10-0.5QX


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CurveCurve

Inverse relationship between the price and theInverse relationship between the price and the

quantity demanded. This is shown by thequantity demanded. This is shown by thedownward sloping demand curve.downward sloping demand curve. Price is an independent variable and thePrice is an independent variable and the

demand is dependent. It is the effect of price ondemand is dependent. It is the effect of price ondemand and not vice versa.demand and not vice versa.

Reasons underling the law of demand- thisReasons underling the law of demand- thisinverse relationship can be explained in termsinverse relationship can be explained in termsof two reasons, viz,of two reasons, viz, Income EffectIncome Effect

Substitution EffectSubstitution Effect


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Exceptions to Law of DemandExceptions to Law of Demand

Veblen GoodsVeblen Goods

Giffens goodsGiffens goods

Speculative MarketsSpeculative Markets IgnoranceIgnorance

h i dCh i D d


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Change in DemandChange in Demand

Extension and Contraction of DemandExtension and Contraction of Demand It is due to change in the price, other thingsIt is due to change in the price, other thingsremaining constantremaining constant

Change is shown along the same demandChange is shown along the same demand

curvecurve Increase and Decrease in DemandIncrease and Decrease in Demand

It is due to change in factors other than priceIt is due to change in factors other than price

Change is shown by shift in demand curveChange is shown by shift in demand curve


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DemandDemand


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Utility and Its ApproachesUtility and Its Approaches

Utility is a want satisfying capacity ofUtility is a want satisfying capacity ofa commoditya commodity

There are two approaches to utilityThere are two approaches to utility

Cardinal Approach (Marshall)Cardinal Approach (Marshall)

Ordinal Approach (Hicks)Ordinal Approach (Hicks)

Cardinal Approach is based on law ofCardinal Approach is based on law ofdiminishing marginal utilitydiminishing marginal utility

Ordinal Approach is explained withOrdinal Approach is explained withindifference curve analysisindifference curve analysis


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UtilityUtility

It states that Other things remaining

the same, as a consumer increaseshis consumption of goods, theMarginal Utility eventually starts

declining.


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Utility ScheduleUtility Schedule

QuantityQuantity Total UtilityTotal Utility Marginal UtilityMarginal Utility

22 88 --

33 1818 101044 2626 88

55 3131 55

66 3333 2277 3333 00

88 3232 -1-1


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i i i f f


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Limitations of Law of DMULimitations of Law of DMU

It is based on the unrealistic assumptionIt is based on the unrealistic assumption

of cardinal measurement of utility. Utilityof cardinal measurement of utility. Utilityis a psychological term which can not beis a psychological term which can not bemeasured in terms of numbers and units.measured in terms of numbers and units.

It is applicable only for one commodity.It is applicable only for one commodity. It does not explain the impact of theIt does not explain the impact of the

complementary and substitute goods oncomplementary and substitute goods onthe demand.the demand.

It cannot explain the impact of changes inIt cannot explain the impact of changes inthe income on demand.the income on demand.

O di l ili h


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Ordinal Utility ApproachOrdinal Utility Approach

According to this approach instead ofAccording to this approach instead of

measuring the utility in terms of themeasuring the utility in terms of thenumber, given a choice from the basketnumber, given a choice from the basket

of commodities a consumer can rank theof commodities a consumer can rank the

commodities according to theircommodities according to their

preferences.preferences. The higher order of preference is given toThe higher order of preference is given to

the commodity which will give a higherthe commodity which will give a higher

utility. Thus this theory is also know as theutility. Thus this theory is also know as therevealed preference theory.revealed preference theory.

This approach is explained with the help ofThis approach is explained with the help of

indifference curve analysis.indifference curve analysis.

El ti it f D dEl ti it f D d


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Elasticity of DemandElasticity of Demand Elasticity is defined as the ratio of theElasticity is defined as the ratio of the

percentage change in quantity demandedpercentage change in quantity demanded

to the percentage change in some factorto the percentage change in some factor(such as price or income) that stimulates(such as price or income) that stimulatesthe change in quantity.the change in quantity.

Elasticity is an index of reaction.Elasticity is an index of reaction.

It measures the extent of change in demandIt measures the extent of change in demandfor commodity X in response to change infor commodity X in response to change inthe factor determining demand for X.the factor determining demand for X.

In other words it measures how muchIn other words it measures how much

demand for X changes in response todemand for X changes in response tochange in price of X, Mathematically,change in price of X, Mathematically,

E = % change in DE = % change in DXX / % change in (f/ % change in (fXX))


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Price Elasticity of DemandPrice Elasticity of Demand

It measures the extent of change inIt measures the extent of change indemand for commodity X in responsedemand for commodity X in response

to change in the Price of Xto change in the Price of X

Mathematically,Mathematically,EE

PP= % change in D= % change in D

XX/ % change in (P/ % change in (P

XX))


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Cross Elasticity of DemandCross Elasticity of Demand


to change in the Price of Rto change in the Price of R

Mathematically,Mathematically,EECC = % change in D= % change in DXX / % change in P/ % change in PRR

In case of Complementary Goods theIn case of Complementary Goods the

relationship shall be inverserelationship shall be inverse In case of substitute goods theIn case of substitute goods the

relationship shall be directrelationship shall be direct


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Income Elasticity of DemandIncome Elasticity of Demand


to change in the Income / Budget ofto change in the Income / Budget of

the consumerthe consumer Mathematically,Mathematically,

EEYY= % change in D= % change in D

XX/ % change in Y/ % change in Y

The relationship shall be usually The relationship shall be usuallydirectdirect


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Promotion ElasticityPromotion Elasticity


to change in Advertising Budget ofto change in Advertising Budget of

the producerthe producer Mathematically,Mathematically,

EEAA= % change in D= % change in D

XX/ % change in A/ % change in A

The relationship shall be usually The relationship shall be usuallydirectdirect


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Types of ElasticityTypes of Elasticity

Unit Elasticity (E = 1)Unit Elasticity (E = 1) Relatively Elastic ( E < 1)Relatively Elastic ( E < 1)

Relatively Inelastic (E > 1)Relatively Inelastic (E > 1)

Perfectly Inelastic (E = 0)Perfectly Inelastic (E = 0)

Perfectly Elastic (E = )Perfectly Elastic (E = )


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02 - DEMAND AND UTILITY ANALYSIS

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