Unit 2

UNIT -2 CONSUMER AND PRODUCER BEHAVIOUR

“Demand is the mother of production”

“If you can’t pay for a thing, don’t buy it. if you can’t get paid for it don’t sell it”

-Benjamin Franklin

INTRODUCTION

• MARKET – It refers to the interaction between sellers and

buyers of a goods/service at a mutually agreed on price.

• Success of any business is determined by the extend and magnitude of demand and the rate of growth of demand.

• So one must know about the demand and supply concepts then how this bring out the price determination in the market.

DEMAND • In a day to day life we need various goods and

services.

• It said human wants are unlimited.

• DEMAND – It is defined as the want, need or desire which is

backed by willingness and ability to buy a particular commodity in a given period of time.

– It is the quantity of a commodity which consumers are willing to buy at given price for a particular unit of time(day/week/month)

– It is a effective desire as it is backed by willingness to pay and ability to pay.

TYPES OF DEMAND

• Based on nature of commodity, time unit for which it is demanded and relation between two goods

– Direct and derived demand

– Recurring and replacement demand

– Complementary and competing demand

– Individual and market demand.

DIRECT AND DERIVED DEMAND • DIRECT

– When a commodity is demanded for its own sake by the final consumer it is known as consumer goods(ALL HOUSE HOLD ITEMS) and its demand is direct demand • Example – FMCG , house hold items(TV ,

refrigerator…)

• DERIVED DEMAND – When a commodity is demanded for using it

either as a raw material or as an intermediary for value addition in any other good or in same good is known as capital good and its demand is derived demand • Example – machineries

RECURRING AND REPLACEMENT DEMAND

• Consumer goods are divided into consumable and durable categories

• Consumable goods – Recurring demand – The are consumed at frequent intervals

• Example – food items, petrol, soft drinks etc

– Consumers make purchases on short term basis so pricing should done accordingly

• Durable goods- Replacement demand – They are purchased to be used for long time

– Wear and tear of goods need replacement • Example- TV, cars, mobile phones, capital goods(

machineries) etc.

COMPLEMENTARY AND COMPETING DEMAND

• Goods which create joint demand are complementary goods.

• Demand for one commodity depends upon demand of another one.

– Example – automobiles/petrol, computer/software etc.

• Goods that compete with each other to satisfy any particular wants are called competing demand

– Example – tea /coffee, sugar/sugar free

INDIVIDUAL AND MARKET DEMAND

• Demand for an individual consumer is normally expressed as individual demand.

• The theory of demand is based on individual demand.

• Demand by all consumers for its product is known as market demand.

• Demand for the product produced by all the firms in the industry is known as industry demand

DETERMINANTS OF DEMAND

• Factors which determine the demand for any product – Price of the product(price has a negative effect on

demand) – Income of the consumer(normal goods/inferior

goods) • Normal goods(positive relation) inferior (negative relation)

– Price of related goods(substitute/complementary products)

– Taste and preferences – Advertising – Consumers expectation of future income and price – Population – Growth of economy

DEMAND FUNCTION

• The relation between demand and its determinants mathematically that relationship is known as demand function.

• Demand for a product X Dx=f (Px, Y, Po, T, A, Ef, N)

• Px – price of the commodity

• Y – income of the consumer

• Po – price of related goods

• T – taste and preference

• A – advertising

• Ef – future expectations

• N – population and economic growth

It is a multivariate demand function

LAW OF DEMAND

“Law of demand states that others things remains constant(ceteris paribus) when the price of a commodity rises the demand for the commodity falls and when the price of a commodity falls, the demand for that commodity rises”

• The demand for the product is inversely proportional to its price

…contd

• Demand is the negative function of price .

• So such a function can also be in the form of an exact relation between demand and price, either linear or non linear form.

• Linear demand function Dx= a-bPx

a= constant

b= slope

• Non linear demand function Log D= a- b Log P

.. contd

• The law can be understood with the help of

– Price effect

– Substitution effect

– Income effect

– Law of diminishing marginal utility

• As per law of diminishing marginal utility , the utility derived from every next unit( marginal unit) of a commodity consumed goes on falling

TEST FOR YOUR UNDERSTANDING

CASE ANALYSIS

Assume that there is a fruit seller who has 20 KG of oranges to be sold and he wants to fix a price. So that all apples are sold. There are 3 customers in the market and their individual demand functions are

D1=35-1.0P

D2= 25-.5P

D3= 10 -1.5P

Determine the market demand for the fruit seller?

Find out the price at which he can sell all oranges?

DEMAND SCHEDULE AND DEMAND CURVE

• Law of demand can be further explained with the help of demand schedule and demand curve.

Demand schedule POINT ON DEMAND

CURVE PRICE DEMAND

A 20 50

B 25 40

C 30 30

d 35 20

DEMAND CURVE

• The demand curve shows the relation ship between price of good and the quantity demanded by consumers.

• The demand curve for firm is achieved by the horizontal summation of individual demand curves and that of the industry by adding curves of all the firms.

…contd

X axis- quantity y axis- price

D

D

30

20

10

20 40 50

LINEAR DEMAND CURVE


D

D

30

20

10

20 40 50

SHIFT IN DEMAND CURVE • Shift of demand curve due to a change in any

of the factors other than price is a change in demand.

• The movement along the same demand curve is known as a contraction or expansion in quantity demanded(due to fall or rise in price).

• Where as shift of demand curve due to change in any of factors other than price is known as change in demand.

DEMAND SCHEDULE WITH INCOME

• Demand curve shifts to the right if income rises and shifts to the left if income falls .

POINT ON DEMAND CURVE

PRICE DEMAND (INCOME 20K/M)

DEMAND (INCOME 30K/M)

A 20 50 60

B 25 40 50

C 30 30 40

CHANGE IN DEMAND


D D1

D1

D D2

30

20

10

20 40 50

EXCEPTIONS TO THE LAW OF DEMAND

• There are few cases where the law does not hold good. so therefore these are regarded as exceptions to the law.

• These are goods demanded less at low price and more at high price

• The exceptions cases for – Giffen goods(direct price demand relationship)

• Examples…………………….?

– Snob appeal(consumer measures the satisfaction not by utility value but by social status) • Examples………………?

…contd

• Demonstration effect – Influence of persons behavior by observing the

behavior of others.

• Future expectations of prices – Panic buying – when people increase the purchase

of goods with the expectations that prices will rise more in the future.

• Goods with no substitute – Examples…….?

SUPPLY

Supply refers to the quantities of a good or services that the seller is willing and able to provide at a price at a given point of time, other things are remain same(ceteris paribus)

DETERMINANTS OF SUPPLY • Supply is positively related to price of the

commodity.

• Factors which determine the supply of the product.

– Price of the commodity.

– Cost of production.

• Supply reduced if cost of production increases

– State of technology.

– Number of firms.

– Government polices.

SUPPLY FUNCTION • The mathematical relation between supply

(dependent variable) and its determinants( independent variable)the functional representation is termed supply function.

• Thus the supply of product X(Sx) is afunction of – Price of the product(Px)

– Cost of the production( C )

– State of technology( T )

– Government policy ( G )

– Other factors ( N )

Sx = (Px,C,T,G,N)

…CONTD

• Similar to the demand function, a firm’s supply function (Sx) for a good X can be simplified by holding constant the values of all variables other than price of the good

S=f(P)

• A linear supply function return in form of

Qs = c+d P

C- constant

d - slope

LAW OF SUPPLY • The law of supply states that other things

remaining the same, the higher the price of a commodity, the greater is the quantity supplied.

• Higher price means higher revenue to the supplier and high incentive to supply.

SUPPLY SCHEDULE Point on supply curve Price supply

A 10 15

B 20 30

C 30 40

d 40 50

SUPPLY CURVE


S

S

45

30

15

5 10 15

LINEAR SUPPLY CURVE


S

S

45

30

15

5 10 15

SHIFT IN SUPPLY CURVE

• Change in quantity supplied refers to movements along the same supply curve due to change in the price of the commodity.

• Change in supply is associated with change in factors like costs of production, technology etc.

• Change in supply is a shift in the supply curve upwards or down wards due to non price determinant of supply.

..contd

Point on supply curve

Price Supply(old machine)

Supply(new machine)

A 10 15 20

B 20 30 35

C 30 40 45

d 40 50 55

SHIFT IN SUPPLY CURVE


S1 S S2

S1

S S2

30

20

10

20 40 50

MARKET EQUILIBRIUM

• So far you know the price affects demand and supply.

• But with this knowledge you determined the price…………… NO

• The price is determined in the market by the interaction of demand and supply.

• By taking market demand curve and market supply curve we try to strike the equilibrium price.

• In this where both the players (consumers and producers are satisfied)

…contd

• Market equilibrium implies that there is neither excess demand nor excess supply.

• Equilibrium in market occurs when the price is reached where the demand for and supply of a commodity are equal to each other.

Price Supply demand

15 10 40

20 15 35

25 30 30

30 40 25

MARKET EQUILIBRIUM-GRAPH


S

E

D

30

30

… CONTD

• The point of intersection E shows equilibrium price.(demand=supply)

• Any point above or below E will create disequilibrium in the market and the two forces of demand and supply will keep on changing till the point on intersection is attained.

• At point E both buyers and sellers are satisfied.

• Since equilibrium demand matches a supply it express in the mathematical notation of

• Qd(P)=Qs(P)

EXCESS SUPPLY

• The quantity supplied is more than quantity demanded means excess supply.

• Example – Price = 20

– Demand = 10

– Supply = 30 • Higher price consumers are willing to buy less

• It expressed in mathematically • ES=Qs-QD

EXCESS SUPPLY-GRAPH


S

E

D

20

10 30

EXCESS DEMAND

• The quantity demanded is more than quantity supplied means excess demand.

• Example

– Price (low)=10

– Demand= 40

– Supply = 20

• It expressed in mathematically • ED=Qd-Qs

EXCESS DEMAND-GRAPH


S

E

D

10

20 40

CHANGES IN MARKET EQUILIBRIUM

• Comparative statics is the process of comparison between two equilibrium positions.

– Changes in demand.

– Changes in supply.

CHANGE IN DEMAND AT CONSTANT SUPPLY


S1

E1

E

D2

D1

P1 P*

Q* Q1 RISE IN EQUILIBRIUM PRICE AND QUANTITY

CHANGE IN BOTH DEMAND AND SUPPLY


S1

S2

E

E2

D1

P* P2

Q* Q2 DECREASE IN EQUILIBRIUM PRICE AND QUANTITY

CHANGE IN SUPPLY AT CONSTANT DEMAND


S1

S2

E1

E2

D2

D1

P1 P2

Q1 Q2

THE INCREASE IN BOTH SUPPLY AND DEMAND WILL CAUSE SALES TO RISE. BUT THE EFFECT OF PRICE CAN BE +,-,0 IS DEPENDING UPON EXTEWNT OF SHIFTS IN THE CURVES

CONSUMER PREFERENCE AND CHOICES

CONSUMER CHOICE

Demand for a commodity is determined by various factors including income and taste of the consumer and price of the commodity.

UNDERLYING ASSUMPTIONS

• The explanation of consumers choices, tastes and preferences rest on the following assumptions

– Completeness

• Own preference or indifference between two products

– Transitivity

• Consumer preference always consistent

– No satiation

• More is always wanted

• If some is good more of the good is better.

UTILITY ANALYSIS

• Utility is the satisfaction a consumer derives out of consumption of a commodity.

• It may also defined to be an attribute of a commodity to satisfy a consumer wants.

• Utility analysis ids the corner stone of consumer behavior.

• Mathematically we can express utility as the function of the quantities of different commodities consumed – U=f(m1,n1,r1) (m1,n1,r1- quantities of different

commodities)

….contd

“A rational consumer aims at maximizing his/her utility from consumption of different commodities subject to budget constraint”

Two types of utility analysis – Cardinal utility analysis

• According to this utility is quantifiable in units

– Ordinal utility analysis • According to this utility cannot be measured it can be

shown as high or less

CARDINAL UTILITY

• The economist like MARSHALL and JEVONS opined that utility is measurable like any other physical commodity and proposed UTILS as a units.

• According to them utility is a cardinal concept and we can assign number of utils to any commodity.

• Utility is an additive we can add the utility of commodities.

TOTAL UTILITY & MARGINAL UTILITY • Total utility

• Refers to the sum total utility levels out of each unit of a commodity consumed within a given period of time. OR other words total satisfaction from consumption.

• Marginal utility

• It is change in total utility due to a unit change in the commodity consumed within a given period of time. OR other words it is the total utility of additional (nth) unit consumed of the commodity.

MU= d TU/d Q

When a consumer continues to have more and more units of a commodity his total utility increases, but his marginal utility decreases

LAW OF DIMINISHING MARGINAL UTILITY

• As per the law of diminishing marginal utility, marginal utility for successive units consumed goes on decreasing.

UNITS OF CONSUMPTION

TOTAL UTILITY MARGINAL UTILITY

0 0 -

1 20 20

2 35 15

3 45 10

4 56 5

5 56 0

6 50 -3

TOTAL AND MARGINAL UTILITY CURVE

1 2 3 4 5 6

TOTAL UTILITY 20 35 45 56 56 50

MARGINAL UTILITY 20 15 10 5 0 -3

-10

0

10

20

30

40

50

60

TU A

ND

MU

TOTAL UTILITY - CURVE

X AXIA – QUANTITY Y AXIS- TU OF X

TU

MARGINAL UTILITY - CURVE

X AXIA – QUANTITY Y AXIS- MU OF X

MU

LAW OF DIMINISHING MARGINAL UTILITY- ASSUMPTIONS

• The unit of consumption must be standard one. – Too large and too small not valid

• Consumption must be continuous.

• Multiple units of commodity should be consumed. – Not for durable goods

• The taste and preferences of the consumer should remain unchanged during the course of consumption

• The good/commodity should be normal nor addictive in nature

LAW OF EQUIMARGINAL UTILITY

• In real life a consumer buys multiple commodities at the same time to satisfy diverse wants.

• The law of equimarginal utility explains how a consumer would spend his income on different commodities.

• As per the law of equimarginal utility, marginal utilities of all commodities should be equal.

..contd

• ASSUMPTION – The consumer has a fixed income

– Their purchase decision on the basis of price of different commodities to be consumed.

• According to the law of equimarginal utility, a consumer will maximize utility

• when the marginal utility of the last unit of money spent on each commodity is equal to marginal utility of the last rupee spent on any other commodity

EQUIMARGINAL UTILITY - FORMULA

Mum = Mun = ……. =MU1

-------- ---------

Pm Pn

MARGINAL UTILITY AND DEMAND CURVE

• The consumer would continue to consume subsequent units of a commodity till the marginal utility of the commodity is equal to its own price.

• The marginal utility curve of commodity MU is downward sloping.

MARGINAL UTILITY AND DEMAND CURVE

X AXIS – QUANTITY Y AXIS- PRICE

QA QB QC

PA PB PC

QA, QB,QC= QUANTITY OF COMMODITY

PA,PB,PC= PRICE OF THE COMMODITY

AT POINT C (MU=Pc) AT POINT B(MU=PB) AT POINT A(MU=PA)

INFERENCE FROM GRAPH

• The price goes on increasing the desired consumption of the commodity for the consumer goes on diminishing.

• This would lead us to the individual demand curve of the commodity.

CONSUMER PREFERNCES

• Ordinal utility – It avoid the physical measurements of utility

– EDGEWORTH AND FISHER

• According to ordinal utility theory utility cannot be measured in physical units rather the consumer can only rank utility derived from various commodities.

• According to the ordinal utility approach utility is not additive

INDIFFERENCE CURVE ANALYSIS

• In difference curve analysis was introduced by J.R.HICKS AND R.G.D ALLEN .

• The crux of this analysis is that utility is ordinally measurable.

• According to ordinal school, a consumer is able to rank different combinations of the commodities in order of preference or indifference.

…contd

• We may define an indifference curve as the locus of points which show the different combinations of two commodities a consumer is indifferent about.

• All the points in the curve render equal utility to the consumer.

• The indifference curve is also known as an isoutility

IN DIFFERNCE SCHEDULE

• All the different combinations render the same level of utility namely U

COMBINATION COFFEE PUFF TU

A 1 6 U

B 3 3 U

C 4 2 U

D 7 1 U

0

1

2

3

4

5

6

7

1 3 4 7

CO

FFEE

PUFF

INDIFFERENCE CURVE

i3

i2

i0 i1

io- low satisfaction i2,i3- HIGH SATISFACTION COMPARE TO io

PROPERTIES OF INDIFFERENCE CURVE

• Down ward sloping.

• Higher indifference curve represents high utility.

• Indifference curve can never intersect.

• Convex to the orgin

– Two goods are not substitute to each other.

DIMINISHING MARGINAL RATE OF SUBSTITUTION

• MRS is a proportion of one good that the consumer would be willing to give up for more or another.

• The marginal rate of substitution of M for N (MRS mn)

– It would be the amount of commodity N that the consumer would be willing to give up for additional unit of M.

• MRS mn= -( ∆ N /∆M)

Why MRS has a negative sign(to increase consumption M reduce consumption of N)

MRS -SCHEDULE

COMBINATION M N MRS

A 1 5 -

B 3 4 1.5

C 5 3 1

D 8 1 0.2

INDIFFERENCE CURVES – SPECIAL TYPES

• (a)Negatively sloping linear indifference curve – M and N perfectly substitutes

• (b)Right angle indifference curve – M and N are perfectly complements

• (c) Concave indifference curve

• (d) Positively sloping indifference curve – For non good commodity(bad)

• Example – non healthy products

a) b)

c) d)

X axis- Q m Y axis- Q n

CONSUMER’S INCOME

• Up to past we discussed about consumer preference as one aspect of consumer behavior.

• The second very important aspect namely constraints to the consumer in satisfying his wants.

• Such constraints include income of the consumer and prices of the commodities in the consumption basket

EXPLANATION • Assume that the consumer spends all his

income on the two commodities M and N

• The price unit of M is Pm and N is P n.

• The income of the consumer is I

• We can express the budget constraint of the consumer in the form of budget equation

• Pm x Q m + P n x Q n =I

• Q m and Q n are the quantities purchased of M and N

..contd

• We can also deduce the quantities of the commodities purchased from the budget equation by algebraic treatment

• Q m = (I/Pm ) - ( P n/Pm ) x Q n

• Q n = (I/P n) - (Pm/P n) x Q n

BUDGET LINE- ( SAME CONCEPT OF PPF)

A

R

S

B

XAXIS – QUANTITY OF M YAXIS – QUANTITY OF N

R- NOT ATAINABLE S- NOT DESIRABLE

POINT ON LINE AB-

FEASIBLE

SLOPE OF THE BUDGET LINE = Pm/Pn

SHIFT IN BUDGET LINE

A1

A’

A

A2

B2 B B1 B’

X AXIS – QUANTITY OF M Y AXIS QUANTITY OF N

GRAPH- INTERPRETATION • Line AB- initial budget line • Consumer income raises (price of M and N

constant) – Line AB Shift to A1 B1

• Consumer income downs(price of M and N constant) – Line AB Shift to A2 B2

• Price of M falls (price of N and consumer income constant) – Line AB Shift to A B’

• Price of N falls (price of M and consumer income constant) – Line AB Shift to A’ B

CONSUMER’S EQUILIBRIUM

• Consumer’s equilibrium is at the point where the budget line is tangent to the highest attainable indifference curve by the consumer subject to budget constraint.

• The consumer equilibrium is understood by combining the budget line and indifference curve.

CONSUMER’S EQUILIBRIUM

A

Q n i3

i2

i0 i1

X- AXIS – Q m Y –AXIS – Q N i0- low satisfaction i2,i3- high satisfaction compare to i0 AB – BUDGET LINE

Q m B

CONDITIONS FOR CONSUMER’S EQUILIBRIUM

• The consumer spends all income in buying the two commodities.

• Hence the point of equilibrium will always lie on the budget line.

• The point of equilibrium will always be on the highest possible indifference curve the consumer can reach with the given budget line.

• At optimum bundle slope of indifference curve should be equal to the slope of budget line.

• Mum/Mun = Pm/Pn

REVEALED PREFERENCE THEORY

• Samuelson introduced the term REVEALED PREFERENCE.

• According to this theory the demand for a commodity by a consumer can be ascertained by observing the actual behavior of the consumer in the market in various price and income situations.

• The basic hypothesis of theory is choice reveals preference

CONSUMER’S SURPLUS

• Consumers surplus is the difference between the price consumer are willing to pay and what they actually pay.

• Example

– Person X wanted to buy a shirt and had decided to pay a maximum amount of Rs 1000 for it.

– But he got a shirt of choice for Rs 800 (full utility).

– The difference Rs 200 is person X surplus

CONSUMER SURPLUS - GRAPH

D

P1 A S

P2 B

P* E

S D

Q1 Q2 Q*

X AXIS – QUANTITY Y AXIS - PRICE

CONSUMER SURPLUS P1-P* P2-P*

CONSUMER SURPLUS

TRIANGLE= P*DE

ELASTICITY OF DEMAND

INTRODUCTION

• Recall the law of demand.

• Please answer…….

– If price of the product increases by one unit. By what proportion will quantity demanded decrease?

• The law of demand gives only the direction of change of quantity (according to price changes) not the magnitude of such a change.

• In order to know the magnitude you need to know the concept of elasticity of demand.

…contd

• In fact why only price? NO

– A firm need to know about the responsiveness of demand for the commodity it produces to changes in all the independent variables like

• Income, price, advertisement, substitute products etc, that influence its demand

• Knowledge of elasticity would obviously help firms in major policy decisions like pricing.


• Elasticity of demand measures the degree of responsiveness of quantity demanded of a commodity to a given change in any of the determinants of the demand.


• Mathematically it means the percentage change in quantity demanded of a commodity to a percentage change in any of the independent variables that determine demand for the commodity.

TYPES OF ELASTICITY OF DEMAND

• We restrict to four but many types of elasticity of demand as the number of determinants of demand. – Price elasticity

– Income elasticity

– Cross elasticity

– Promotional (advertising elasticity)

• In order to assess the impact of one variable we assume other variables as constant(ceteris paribus)

PRICE ELASTICITY OF DEMAND

• Price is considered to be most important among all the independent variables that affect demand for any product.

• So price elasticity of demand is important among all other elasticity of demand.

• Price elasticity of demand measures the proportionate change in quantity demanded of a commodity to a given change in its price.

DEGREES OF ELASTICITY OF DEMAND

Is the elasticity of demand is same as slope of demand curve?

………………………………………………answer…?

..contd

• The demand curve will show different degree of elasticity at its different points.

• It is commonly said that flatter the demand curve higher is the elasticity and steeper the demand curve lesser is the elasticity.

DIFFERENT DEGREES OF ELASTICITY

• Perfectly elastic demand

• Highly elastic demand

• Unitary elastic demand

• Relatively inelastic demand

• Perfectly inelastic demand

PERFECTLY ELASTIC DEMAND

• This is one extreme of the elasticity range.

• Elasticity = infinity ( ep=α).

• The perfectly elastic demand curve is horizontal line parallel to quantity axis.

• Unlimited quantities of the commodity can be sold at prevailing price.

PERFECTLY ELASTIC DEMAND CURVE


D

D

Q1 Q2

HIGHLY ELASTIC DEMAND

• When proportionate change in quantity demanded is more than a given change in price.

• It expressed in ep > 1

• It is a flattered demand curve.

• Example – Luxury goods

• Small decrease in price from P1 to P2 leads to greater increase in quantity demanded from Q1to Q2

HIGHLY ELASTIC DEMAND CURVE


D

D

P1

P2

Q1 Q2

UNITARY ELASTIC DEMAND

• When a given proportionate change in price brings about an equal proportionate change in quantity demanded.

• It expressed in ep = 1

• It is uncommon in real life.

• Demand curve with unit elasticity are shaped like rectangular hyperbola.

• If the fall price is P1 – P2 results in equal increase in quantity demanded equal to Q1 – Q2

UNITARY ELASTIC DEMAND CURVE


D

D

P1

P2

Q1 Q2

RELATIVELY IN ELASTIC DEMAND • When change in quantity demanded is found

to be offset by change in its price, then the commodity has a relatively in elastic demand.

• Proportionate change in commodity demanded is less than proportionate change in price

• It expressed in ep < 1

• This demand curve is steeper called necessities

• Large decrease in price of the commodity P1 to P2 leads to small increase in demanded quantity Q1 to Q2

RELATIVELY INELASTIC DEMAND CURVE


D

D

P1

P2

Q1 Q2

PERFECTLY IN ELASTIC DEMAND

• This is the other extreme of elasticity range.

• Elasticity is equal to zero ( ep = 0)

• In this case the quantity demanded of a commodity remains same irrespective of any change in price.

• This commodity are termed as neutral and have vertical demand curve.

• Prices changes from P1 to P2 but quantity demanded remain same at Q1.

PERFECTLY INELASTIC DEMAND CURVE


D

D

P1

P2

Q1

METHODS OF MEASURING ELASTICITY

• Ratio or percentage method

• Arc elasticity method

• Total out lay method

RATIO /PERCENTAGE METHOD

“In ratio method price elasticity of demand is expressed as the ratio of proportionate change in quantity demanded and proportionate change in the price of the commodity”

FORMULA- RATIO METHOD PROPORTIONATE CHANGE IN QUANTITY DEMANDED OF

COMMODITY X ep = ----------------------------------------------------------------------------- PROPORTIONATE CHANGE IN PRICE OF

COMMODITY X (Q2 - Q1 ) / Q1 ep = ---------------------------------- (P2 - P1 ) / P1 Q1- ORGINAL QUANTITY DEMANDED P1 – ORGINAL PRICE LEVEL Q2 - NEW QUANTITY DEMANDED P2 - NEW PRICE LEVEL

ARC ELASTICITY METHOD • Arc elasticity is used as a measure incase the

available figures on price and quantity are discrete.

• It is possible to isolate and calculate incremental changes.

• This method is used when we want to calculate price elasticity of demand between any 2 points on demand curve.

• Arc elasticity measures elasticity at the midpoint of an arc between any two points on a demand curve.

FORMULA- ARC METHOD

(Q2 - Q1 ) /{ (Q1 +Q2)/2}

ep = ---------------------------------------------

(P2 - P1 ) /{ (P1+P2)/2}

Q1- ORGINAL QUANTITY DEMANDED P1 – ORGINAL PRICE LEVEL

Q2 - NEW QUANTITY DEMANDED P2 - NEW PRICE LEVEL

TOTAL OUT LAY METHOD

• It propose by marshall

“ According to total outlay method elasticity is measured by comparing expenditure levels before and after any change in price”

DETERMINANTS OF PRICE ELASTICITY OF DEMAND

INCOME ELASTICITY OF DEMAND

“Income elasticity of demand measures the degree of responsiveness of demand for a commodity to a given change in consumer’s income”

• When we measure the income elasticity of demand we assume all other variables are given ceteris paribus

FORMULA- INCOME ELASTICITY OF DEMAND

PROPORTIONATE CHANGE IN QUANTITY DEMANDED OF

COMMODITY X ep = ----------------------------------------------------------------------------- PROPORTIONATE CHANGE INCOME OF CONSUMER

(Q2 - Q1 ) / Q1 ep = ---------------------------------- (Y2 - Y1 ) / Y1 Q1- ORGINAL QUANTITY DEMANDED Y1 – INITIAL LEVEL OF INCOME Q2 - NEW QUANTITY DEMANDED Y2 - NEW LEVEL OF INCOME

DEGREES OF INCOME ELASTICITY

• Income elasticity of demand also has similar degrees of elasticity like price elasticity of demand.

• Positive income elasticity. – Example = normal good

• Zero income elasticity. – No change in the demand for a commodity when

there is change in income (neutral goods – salt, match box)

• Negative income elasticity – The demand for particular product decreases when

income increases ( inferior good)

CROSS ELASTICITY OF DEMAND

“ Cross elasticity of demand of a commodity X measures the degree of responsiveness of its demand to a given change in the price of another commodity Y”

• Cross elasticity of demand explains the responsiveness of demand for one good to the changes in price of another related good

• Two types – Positive cross elasticity ( substitutes products -x and y)

– Negative cross elasticity ( complementary goods- x and y)

FORMULA- CROSS ELASTICITY OF DEMAND


COMMODITY X ep = ----------------------------------------------------------------------------- PROPORTIONATE CHANGE IN PRICE OF COMMODITY Y

(Q2x - Q1x ) / Q1x ep = ---------------------------------- (P2 y - P1y ) / P1y Q1x- ORGINAL QUANTITY DEMANDED P1y – INITIAL PRICE LEVEL OF

COMMODITY Y Q2x - NEW QUANTITY DEMANDED P2y - NEW PRICE LEVEL OF

COMMOCITY Y

PROMOTIONAL ELASTICITY OF DEMAND

“promotional elasticity of demand measures the degree of responsiveness of demand to a given change in advertising expenditure”

• Some goods(FMCG) are more responsive to advertising than other ( capital goods).

• ea > 1 – firm should go for heavy expenditure on advertisement.

• ea < 1 - firm should not spend too much on advertisement.

FORMULA- PROMOTIONAL ELASTICITY OF DEMAND


COMMODITY X ep = ----------------------------------------------------------------------------- PROPORTIONATE CHANGE IN ADVERTISING EXPENDITURE

(Q2 - Q1 ) / Q1 ep = ---------------------------------- (A2 - A1 ) / A1 Q1- ORGINAL QUANTITY DEMANDED A1 – INITIAL LEVEL OF

AD EXPENDITURE Q2 - NEW QUANTITY DEMANDED A2 - NEW LEVEL OF

AD EXPENDITURE

IMPORTANCE OF ELASTICITY OF DEMAND

DETERMINATION OF PRICE

BASIS OF PRICE DISCRIMINATION

DETERMINATION OF REWARDS OF FACTORS OF PRODUCTION

GOVERNMENT POLICIES AND TAXATION

DEMAND FORECASTING

MEANING

“ Demand forecasting is an estimate of sales in dollars or physical units for a specified future period under a proposed marketing plan”

- American marketing association.

“Demand forecasting is the tool to scientifically predict the likely demand of a product in future”

DEMAND FORECASTING

• A forecast is a prediction or estimation of a future situation, under given conditions.

Passive forecasts Active forecasts

Forecast

PURPOSE OF FORECASTING DEMAND

• Short Run Forecasts

• Decide on sales policy

• Decide on inventory level.

• Fixing suitable price.

• Deciding on Advertisements and promotional matters.

• Long Run Forecasts

• Capital planning

• Installing production capacity.

• Manpower planning.

• Financial planning.

STEPS INVOLVED IN FORECASTING.

Step 1 • Identification of objective.

Step 2

• Determining the nature of goods under consideration.

Step 3 • Selecting a proper method of forecasting.

step4 • Interpretation of results.

LEVELS OF FORECAST

• Macro economic forecasting.

• Industry demand forecasting

• Firm demand forecasting

• Product line forecasting.

• Segment forecasting.

• New product forecasting.

• Types of commodities for which forecast is to be undertaken

• Miscellaneous factors.

DETERMINANTS FOR CONSUMER DURABLE GOODS

• Population

• Saturation limit of the market.

• Existing stock of the good.

• Replacement demand Vs new demand.

• Income levels of consumers

• Consumer credit outstanding.

• Tastes and scales of preference of consumers.

DETERMINANTS OF CONSUMER GOODS

• Disposable Income.

• Price.

• Size & characteristics of population

• D = f(Yd,P,S)

DETERMINANTS FOR CAPITAL GOODS.

• Growth possibility of the industry of the particular firm. • Norm of consumption of capital goods/unit of installed

capacity. • Excess capacity in the industry. • Forecast for consumer goods. • Existing stock & its age distribution of the capital goods. • Rate of obsolescence. • Financial position of the company. • Tax provisions on repurchase. • Price of Substitute / complementary goods.

METHODS OF FORECASTING

Opinion polling methods Statistical Methods

Forecasting

Complete enumeration

survey

Sample Survey &

Test marketing

End use

(Input-output method)

Consumers survey Sales Force opinion Experts opinion Method

(Delphi Technique)

Opinion polling Methods

Fitting Trend

line by

observation

Time series

analysis

(least squares

method)

Smoothing

methods

ARIMA

method

Box-Jenkin

Technique

Mechanical Extrapolation

(Trend projection methohd

Leading,

Lagging &

Coincident

indicators

Diffusion

indices

Barometric Techiniques Regression method Econometric method

(Simultaneous equation

method)

Stastical Methods

METHODS

• Fitting trend by observation: Involves merely the plotting of annual sales on a graph, observing it and extrapolating it.

• Time Series analysis employing Least Square Method: “Line of best fit” By statistical methods a trend line is fitted and by extrapolating the trend line for future we get the forecasted sales.

– 1) linear trends

– 2) Non linear trends.

…CONTD

• Decomposing a time series: Composed of trend, seasonal fluctuations, cyclical movements and irregular variations – for a long period of time.

• Smoothing methods: It attempts to cancel out the effect of random variations on the values of the series.

– 1) moving average

– 2) Exponential smoothing.

BAROMETRIC TECHNIQUE

• Leading series(indicators) : eg.A) Applications for housing loans - Demand for construction material. B) Birth rate – Demand for school seats.

• Coincident series: GNP – Industrial production.

• Lagging Series: Inventory – Consumer credit outstanding.

• Diffusion indices indicators.

• Regression Equation method – Once the variables are identified, they are expressed as an equation.

• Econometric models : All economic and demographic variables that influence a future are taken into account and build a cause effect relationship.

DEMAND FORECASTING OF NEW PRODUCTS

• Survey of buyer’s intentions.

• Test marketing

• Life cycle segmentation analysis.

– Introduction.

– Growth

– Maturity

– Saturation.

– Decline.

Unit 2

Business

Transcript of Unit 2