CompetitiveMarkets- Demand

IBSection1:Microeconomics

DemandforGoodsandServices

• Basicdefinitionofdemand:• Demandforagoodorserviceisthe

quantitythatpurchasersarewillingandabletobuy atagivenpriceinagivenperiodoftime.

• Effectivedemand:• Onlyifdemandforaproductisbacked

upbyawillingnessandabilitytopaythemarketpricedoesdemandbecomeseffectiveorrealizedoractual.

• Thebasiclawofdemandisthatdemandvariesinverselywithprice–lowerpricesmakeproductsmoreaffordableforconsumers.

Effectivedemand isbackedupwithan

abilitytopay

Potential(latent)demandisnotyetexpressedinthe

market

TheDemandCurve:Price&QuantityDemanded

PriceofCoffee

Quantitydemandedofcoffee

DemandforCoffee

P1

Q1

P2

Q2

P3

Q3

Ahigherpriceleadstoacontraction ofquantitydemanded

Alowerpriceleadstoanexpansionofquantitydemanded

Onlychangesinmarketpricecauseamovementalongthedemandcurve

IncomeandSubstitutionEffectsofaPriceChange

Incomeeffect

• Afallinpriceincreasestherealpurchasingpowerofconsumers

• Thisallowspeopletobuymorewithagivenbudget

• Fornormalgoods,demandriseswithanincreaseinrealincome

Substitutioneffect

• AfallinthepriceofgoodXmakesitrelativelycheapercomparedtosubstitutes

• SomeconsumerswillswitchtogoodXleadingtohigherdemand

•Muchdependsonwhetherproductsareclosesubstitutes

CausesofShiftsintheDemandCurve

1. Changingpricesofsubstitutes incompetitivedemand2. Changingpriceofacomplements– i.e.productsinjointdemand3. Changesintherealincomeofconsumers

– Whenrealincomegoesup,ourabilitytopurchaseincreases,andthiscausesanoutwardshiftinthedemandcurve.

– Butwhenincomesfalltherewillbeadecreaseindemand,exceptforinferiorgoods

4. Changesinthedistributionofincome- amoreequaldistributionofincomecanincreasetotaldemandbecauserelativelypoorerconsumersspendahigherproportionoftheirincome

5. Theeffectsofadvertisingandmarketing6. Interestratesanddemand(e.g.affectingthecostofcredit)7. Changesinthesizeandagestructureofapopulation8. Seasonalfactorsforsomegoodsandservices9. Socialandemotionalfactors influencingpreferencesandchoices

IllustratingShiftsintheDemandCurve

PriceofCoffee

Quantitydemandedofcoffee

D1

P1

Q1 Q2

D2D3

Q3

D1toD3isaninwardshiftofdemand– lessisdemandedateachmarketprice

D1toD2isanoutwardshiftofdemand– moreisdemandedateachmarketprice

Changesinpricedonotcauseshiftsinthedemandcurveforaproduct

MarketDemand:GlobalSalesofWearableDevices

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Shipmentsinmillion

s

Wearable cameras Smartglasses Smartwatches

Healthcare Sports/activitytrackers Wearable 3Dmotiontrackers

Smartclothing

Globalmarketdemandforwearabledevicesissoaring– towhatextentaresocialfactorsmoreimportantthanfactorssuchasincome?

FallingDemand:GlobalSalesofAppleiPods

RisingdemandforsuperiortechnologyproductshascausedApple’sglobalsalesoftheiPodtocollapseinrecentyears

39.41

51.6354.83 54.13

50.31

42.62

35.17

26.38

14.38

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Salesinmillionunits

fiscalyears

ChangingPreferences– MovieConsumptionintheUK

0.0%5.0%10.0%15.0%20.0%25.0%30.0%35.0%40.0%45.0%

Q32010 Q12011 Q32011 Q12012 Q32012 Q12013 Q32013 Q12014 Q32014 Q12015

Shareofre

spondents

BoughtDVD/Blu-ray Anydigital

Paidofficialdigital(DTO/VOD) Unofficialdigital(pirate)

Thepatternofdemandformoviesischanging!Digitalsalesnowaccountfor20%ofsalesandthesharefromphysicalsalesisfalling.

TheConceptofUtility

• Utilityisameasureofthesatisfaction thatwegetfrompurchasingandconsumingagoodorservice

• Totalutility:– Thetotalsatisfactionfromagiven

levelofconsumption• Marginalutility

– Thechangeinsatisfactionfromconsuminganextraunit

• Standardeconomictheorybelievesintheideaofdiminishingreturnsi.e.themarginalutilityofextraunitsdeclinesasmoreisconsumed

Utilityisameasureofsatisfactionfrom

consumption

Doestheutilitywegetaffectour

willingnesstopay?

DiminishingMarginalUtilityandDemandCurve

• Marginalutilityisthechangeinsatisfactionfromconsuminganextraunitofagoodorservice

• Beyondacertainpoint,marginalutilitymaystarttofall(diminish)

• Thishappenswiththe4th unitwhereMUfallsto12

• The8th unitcarrieszeromarginalutilityi.e.totalutilityisconstant

• Ifmarginalutilityisfalling,thenconsumerswillonlybepreparedtopayalowerprice

• Thishelpstoexplainthedownwardslopingdemandcurveforagoodorservice

QuantityConsumed

TotalUtility(TU)

MarginalUtility(MU)

1 10 10

2 24 14

3 40 16

4 52 12

5 61 9

6 68 7

7 72 4

8 72 0

TheParadoxofValue

• TheParadoxofValueisalsoknownasthediamond-waterparadox• Weunderstandthatwaterisnecessarytosustainlifeandthatornaments

suchasdiamondsarejustthat– certainlylifesustaining.• Butwatertypicallyhasalowprice,whileapieceofdiamondjewelryhasa

ahighmarketprice.• Onereasonisthatwaterisabundantrelativetodemandwhereas

diamondsarescarcerelativetodemand• Valueinusei.e.drinkingwatertosatisfyyourthirst• Valueinexchange– whataresourcecanbesoldforinexchangeforother

products.Nothingismoreusefulthanwater:butitwillpurchasescarceanything.Thereverse isusuallytrueforexpensivejewelry

Cheapwater Expensivejewelry

SeasonalDemandforGoodsandServices

• Seasonalityreferstofluctuationsinoutputandsalesrelatedtotheseasonaloftheyear.

• Formostproductstherewillbeseasonalpeaksandtroughsinproductionand/orsales

• DemandforslipperspeaksintherunuptoChristmas

• Demandforplantsatgardencentresislinkedtotheplantingseason

• ThereishighdemandfordecoratingmaterialsbeforetheEasterweekend

• Highstreetretailerssuchasjewelrycompaniesmaysellasmuchas80-90%oftheirproductsoverXmas

• Theatrestakeahigh%oftheirincomeduringpantomimeseason

Easterchocolate

Summerfruits

Winterclothing Skiseasonproducts

Someexamplesofseasonaldemand

Social&EmotionalFactorsInfluencingDemand

Socialfactors:• Socialawarenesse.g.awarenessofhealthrisksfromsmoking,gambling

• Socialnorms - changingnormsofbehavioure.g.demandforrecycledbags

• Socialpressurese.g.peerpressuresaffectingdemandforlegalhighs&otherdrugs

Emotionalfactors:• Emotionalarousalcanaffectthedemandforhealthinsuranceaftermajorincidents

• Bingedrinkingandeatingattimesofpersonalinsecurity

• Demandforproductssuchasfootballseasonticketsandantiquesalsohasastrongemotionalattachment

NetworksandDemandChoices

Increasinglyinthedigitaleconomy,thechoicesmadebyconsumersareinfluencedbythedecisionsofothers.Agoodexampleisthedecisionaboutwhichmessengerapptouse.

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WhatsApp

FacebookMessenger

WeChat

Skype*

Viber*

LINE

Kik*

BlackBerryMessenger

KakaoTalk

Monthlyactiveusersinmillions

*July2015data

MarketDemand– theRiseoftheiPhone!

TheAppleiPhonewaslaunchedin2007andin2015annualsalesareexpectedtoclimbabove230millionunits.(Source:Apple).Inthefirstthreequartersof2015,Appleclaimed92percentofthesmartphoneindustry’saggregateprofits

1.3911.63

20.7339.99

72.29

125.05

150.26169.22

231.22

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2007 2008 2009 2010 2011 2012 2013 2014 2015

Unitsalesinmillions

DerivedDemand

• Deriveddemandisthedemandforafactorofproductionusedtoproduceanothergoodorservice

• Steel:Thedemandforsteelisstronglylinkedtothemarketdemandforcarsandtheconstructionofnewbuildings.

• Wood:Woodisaproductwheremuchofthedemandcomesfromtheusestowhichitcanbeput.– TheenduseofwoodintheUKis:Construction:60%,Furniture:15%,Packaging:15%,Fencing:7%,Other:3%

• Labour:Infactormarkets,thedemandforlabourisderived• Transport:Anincreaseinthedemandforairtravelwillleadtoa

riseinthedemandforairplanepilots.

Theideaofderiveddemand isimportant tousewhendiscussing inter-relationshipsbetweenmarkets.Manyquestionsconsider twoormoremarkets.

CompositeDemand

• Compositedemandexistswheregoodshavemorethanoneuse - anincreaseinthedemandforoneproductleadstoafallinsupplyoftheother

• Anexampleismilkwhichcanbeusedforcheese,yoghurts,cream,butterandotherproductsincludingfertilizer!

• Anotherexampleis land – e.g.farmlandcanbedevelopedinmanydifferentways,urbanlandhasdifferentusesetc.

• Oilisusedinmanydifferentindustriessuchasplastics.

Butter Yoghurt

MilkChocolate Cheese

Unprocessedmilkhasmanyfinaluses

TheFallandRiseofVinylAlbumSalesintheUK

In2014,over1.2millionvinylLPsweresoldintheUK,upfromjust205,000soldin2007.Whatmightexplainthisrebound?

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LPssold

LinearDemandFunctions

• Thedemandfunctioncanbewrittenintheformofanequation• Qa=a=bP whereQdisquantitydemanded• aisaconstant– determinedbynon-pricefactors• Pisthepriceoftheproduct• Forexample:• DemandforProductY=200– 4P• Thereforeifthemarketpriceis£40,thenQd=200– 160=40• Ifthemarketpricefallsto£20,thenQd=200– 80=120• I.e.afallinmarketpricecausesanexpansionofdemand

LinearDemandFunction– ChangesinMarketPrice

• Thedemandfunctionfordailysalesoftakeawaypizzaisestimatedtobe• Qd=500– 5P(wherePisthe$priceofpizza)• Initiallythebusinesssetsapriceof$20foratakeawaypizza• Qd=500– 5(20)=400unitsperday• Followingariseincosts,thepizzacompanyraisestheirpriceto$25,otherconditionsofdemandremainingthesame(ceterisparibus)• Now:Qd=500– 5(25)=500-125=375• Highermarketpricecausesacontractionofdemand

LinearDemandFunction– ChangesinNon-PriceFactor

• Thedemandfunctionfordailysalesoftakeawaypizzaisestimatedtobe• Qd=500– 5P(wherePisthe$priceofpizza)• Initiallythebusinesssetsapriceof$20foratakeawaypizza• Qd=500– 5(20)=400unitsperday• Followingachangeinrealincomesofconsumersthenewdemandfunctionis• Qd=800– 5P• Atapriceof$20,demandforpizzas=800– 5(20)• Newdemand=700.Ariseinrealincomehascausedanoutwardshiftofdemandforpizza.

LinearDemandFunction– ChangesinCoefficient

• Thedemandfunctionfordailysalesoftakeawaypizzaisestimatedtobe• Qd=500– 5P(wherePisthe$priceofpizzaand5isthecoefficientofP)• Ifthemarketpriceofpizzais$20thenQd=400• IfthereisachangeinthecoefficientofPthiswillaffectthesteepnessofthedemandcurve• ThusifthenewlineardemandfunctionisQd=500-8P• Atapriceof$20,thenQd=500– 8(20)=340

CompetitiveMarkets- Demand

IBSection1:Microeconomics