MBA(Marketing) Msc(Economics)
INSRUCTOR:BILAL KHAN
Chapter no 2 Utility analysis of Demand
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Terms to know:
The law of demand1
Demand function2
Demand schedule3
Diagramatical representation4
Elasticity of demand7
Changes in Demand 6
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Meaning of demand. Demand is an effective desire which is supported
by willingness and ability to pay for it. The term demand has three components
1. desire 2.Willingness and 3.Ability to pay for or purchasing power.
..
5
Quantity demanded is the amount of a good that buyers are willing and able to purchase.
Law of DemandThe law of demand states that, for most goods, other things equal, the quantity demanded of a good falls when the price of the good rises;.
“The demand schedule is a table that shows the relationship between the price of a good and the quantity demanded.”
DEMAND
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The Demand Curve The demand curve is the graphic representation of
the law of demand. The demand curve slopes downward and to the right. As the price goes up, the quantity demanded goes
down.
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Definition:
Law of demand states that, other things remaining the same, amount demanded increases with a fall in price and diminishes with rise in price.
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Definition (continued)
Other things remaining the same
Weather conditionPrice of substitute goods
Taxes of the govt.
Taste, habits of the consumer
Income of the consumer
Political stability
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Demand function:
Qd = f(P) Here,
Qd= Dependent variable
P= Independent variable
Demand has a negative relationship with price; i.e.
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Demand schedule:
price Demand1O0 100O9O 10508O 11007O 115O6O 120O50 125O
price Demand1O0 100O110 950120 900130 850140 800150 750
Decrease in price increase in demand Increase in price decrease in demand
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Diagrammatical representation:
PRICES
Quantity demandO 1000 1050 1100 1150
70
80
90
100 Demand curve
D
D
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Graphical presentation of the LOD schedule.
The above given demand schedule is now shown with the help of graph in which there are two axis vertical and horizontal, with the vertical axis the price of product is given while horizontal axis measures the quantity of that product.
a
b
c
d
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Changes in demand:
Changes in the demand for a commodity can be shown through the demand curve in two ways:
Movements along the demand curve:
Shifts in the demand curve:
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Changes in demand:
CHANGE IN DEMAND:Change in demand
Movement along a demand
curve
Shift in the demand
curve
Extension in demand
Contraction in demand
Increase in demand
Decrease in demand
It is caused by change in the price
alone.
It is caused by changes in factors other than the price.
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Changes in demand (cont’d):
Movements along the demand curve:if the change in demand is due to a rise or fall in the price of a commodity alone, it is known as contraction or extantion in demand.
Quantity
Price
2
4
6
8
100 200 300 400
a
b
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Changes in demand (cont’d):
Shift in the Demand curve: If the changes in demand is due to factor other
than price, it is known as increase or decrease in demand.
In such case the demand curve shift to right or left from the original demand curve.
2
4
6
8
100 200 300 400
The demand curve shift to right due to change in other factors.
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Shift in demand curve
A shift of demand curve can also be caused by a change other than price, such as a change in taste, population, fashion, price of complementary goods, price of substitute goods. For example price of complementary goods, car and oil. If price of car increase it will effect demand of petrol due to which the demand curve of petrol shift downward.
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Shift in Demand Curve
price
Quantity Demand
Demand Curve
D1D2
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Conti This diagram shows shift of demand curve. When price of
complementary product increase or decrease it shift the demand curve upward or downward. Here when the price of car increase it effect the demand of petrol due to which the demand curve shift downward. The diagram shows that when price of petrol was 40 Afs, the demand was 70. but when the price of car increase it effect the demand of petrol due to which the demand decrease to 60 Afs, which shift the curve downward.
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Market Demand vs. Individual Demand
Market demand refers to the sum of all individual demands for a particular good or service.
Graphically, individual demand curves are summed horizontally to obtain the market demand curve.
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Price of Rose Bouquets(RB)
Qty of RB demanded by consumer 1
Qty of RB demanded by consumer 2
Market Demand
$13 0 1 1 $12 0 2 2 $11 1 3 4 $10 2 4 6 $9 3 5 8 $8 4 6 10 $7 5 7 12 $6 6 8 14 $5 7 9 16 $4 8 10 18
$33333
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Terms to know:
statement
Degree/Cases of Ed
Schedule of Ed
Diagrammatical representation
Formula form for Ed
Elasticity Elasticity Of demandOf demand
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Elasticity Elasticity of Demand Meaning and concept. Degrees of elasticity of demand1. Perfectly elastic demand.2. Perfectly inelastic demand.3. High/more elastic demand.4. Less elastic demand and5. Unitary elastic demand. Measurement of demand elasticity. Types of demand elasticity.
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Meaning and concept Elasticity . The term elasticity refers to extension and
contraction quality of a good. For example, rubber, Spring, plastic, metals etc. And a good which has no quality of extension and contraction is known as inelasticity or inelastic good. For instance, stone, paper etc.
Demand elasticity. The LOD expresses only inverse relationship b/w price and quantity demanded but it does not show that how much quantity is influenced by change in price. Only elasticity of demand makes us able to know about that how much quantity is effected by change in price.
Thus demand elasticity is the degree of responsiveness of quantity demanded to change in price. In other words, a percentage change in quantity divided by a percentage change in price is called demand elasticity. Mathematically it is written as
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Elasticity of demand:
Statement: To what extent or to what degree quantity demanded changes as a result of change in price is called elasticity of demand (Ed).
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Cont….
% change in QdEd = % change in price
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DEGREES OF ELASTICITY OF DEMAND.
There are five degrees of demand elasticity which show different level of responsiveness of quantity demanded to change in price these are given as
1. Perfectly elastic demand.2. Perfectly inelastic demand.3. High/more elastic demand. 4. Less elastic demand.5. Unitary elastic demand.
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Explanation to the degrees of demand elasticity. Perfectly elastic demand. A demand is said to be
perfectly elastic when the quantity is increasing or decreasing with no change in price, here in this degree price is constant whereas quantity is variable.
Quantity is influenced by other factors rather than price such as, change in income, taste, price of substitutes etc
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Schedule and graph for PED.
price quantity
10 20
10 30
Y
X0
5
10
10 20 30
..D LP
Q
Here the quantity is effected not by price but by other factors such as change in income, taste, price of substitute etc.
a b
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Perfectly inelastic demand Perfectly inelastic demand refers to no change in
quantity with any change in price, whatever the price is the quantity remain unchanged or fixed. The demand for necessary items is perfectly inelastic such as food, medicine etc.
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Cases/Degrees of elasticity of demand:
Elasticity of Elasticity of demanddemand
Less Less elasticelastic
Equal elasticEqual elastic
More elasticMore elastic
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Cases of Ed (cont’d):
Equal elastic
More elastic
Less elastic
If there is a great change in price cause a less change in quantity demand, is called less elastic situation.
If there is an equal change in price cause an equal change in quantity demanded, is called equal elasticity of demand.
If there is a less change in price caused a great change in quantity demand, is called more elastic situation.
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Schedule form of Ed:
50 2O
40 22
Less elastic
Price Demand
15 100
10 200
More elastic
Price Demand12 60
10 70
Price Demand
Equal elastic
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Diagrammatical representation of less elastic demand:
Less elastic curve
20 22
40
50
PRICE
QUANTITY DEMANDED
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Diagrammatical illustration for equal elasticity:
Equal elastic curve
PRICE
QUANTITY DEMANDED
50 60
10
12
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Diagrammatical illustration for more elasticity:
PRICE
QUANTITY DEMANDED
100 200
10
15 More elastic curve
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Measurement of elasticity (Formula for Ed):
The formula form for elasticity of demand is; Elasticity of demand = change in quantity demanded ÷ change in price Quantity Price
Ed = ΔQd ÷ ΔP Q P Ed = ΔQd × P Q ΔP
Ed = ΔQd × P ΔP Q
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Measurement of demand elasticity.
To measure the elasticity of demand economists use 1 or unit for hundred percent change in quantity to change in price. If the elasticity of demand for a good is lees than 1 the demand is said to be less elastic and if the elasticity of demand is greater than 1 then the demand is said to be more elastic. When the elasticity is exactly equal to 1 then the demand is said to be unitary elastic.
Now to find these degrees of demand elasticity, a mathematical formula is given as under.
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Formula for demand elasticity.The elasticity of demand is to be
measured with the help of given formula.
Ed = ∆q the above given formula is used for
price elasticity of demand only such as, more, less and unitary elastic demand.
∆p×
p
q
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Measurement. 1
Price Quantity p 20 10
12 q12Ed = ∆q × p ∆p q
Ed = 2 × 20 = 10 = .4 8 12 24
Here elasticity of demand is less than 1 which shows that demand is less elastic.
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Measurement. 2
Price Quantity
p100 10
90 q18Ed = ∆q × p
∆p q
Ed = 8 × 100 = 800 = 4.4 10 18 180
Here the elasticity of demand is greater than 1 which shows that demand is more or high elastic.
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Measurement. 3
Price Quantity
100 10
50 20Ed = ∆q × p
∆p q
Ed = 10 × 100 = 1000 = 1
50 20 1000
Here elasticity of demand is exactly equal to 1 which shows that demand is unitary elastic.
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Types of Elasticity of Demand:
There are many types of elasticity of demand: i.e.
Price elasticity of demand Income elasticity of demand and Cross elasticity of demand.
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1) Price Elasticity of Demand:
Price elasticity of demand is percentage change in quantity demanded divided by the percentage change in the price.
P.E = %age change in amount demanded / % change in price.
Suppose the price of a commodity increase from 20 to 25. quantity demand decrease from 50 to 40. which is equal to 5÷10 = 0.5 there for price elasticity of demand is 5%.
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Income elasticity of demand: “Income elasticity of demand is the
responsiveness of demand to changes in the income of the consumer.”
Income elasticity is calculated by using the following formula:
Ey = % change in quantity / % change in income
Ey = ΔQ/Q ÷ ΔY/YEy = ΔQ/Q × Y/ΔY
Types of Elasticity of Demand (cont’d):
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Types of Elasticity of Demand (cont’d):
Income elasticity of demand is:a) Equal to unity i.e. when the proportion of income spent on
goods remains the same even after increase in income.Ey = 1
b) It is less than unity if the proportion decreases.Ey < 1
a) More than unity if the proportion increases.Ey > 1
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Types of Elasticity of Demand (cont’d):
For example:
monthly income of the consumer (Afs)
Monthly demand for meat (Kg)
5000 40
8000 50
Ey = ΔQ/ΔY × Y/QEy = 10/3000 × 5000/40Ey = 0.14Ey = 0.14 < 1
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Types of Elasticity of Demand (cont’d):
Cross elasticity of demand: “The rate of responsiveness of quantity demanded
of commodity A to changes in price of commodity B.” i.e.
EAB = % change in Qd of A ÷ % change in price of BEAB = ΔQA/QA ÷ ΔPB/PB
EAB = ΔQA/QA × PB/ΔPB
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Types of Elasticity of Demand (cont’d):
For example:Price of wheat (PB)
Quantity demand for rice (QA)
200 1000
300 1200
EAB = ΔQA/ΔPB × PB/QA
EAB = 200/100 × 200/1000EAB =2/5 = 0.4<1
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Extension or Contraction of Demand
Extension of Demand: An extension of demand caused by a fall in price. When price decrease demand increase which extend the demand and curve moved upward.
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Extension of Demand
Price
Quantity Demand
P1
P2
D1 D2
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Contraction of demand caused by a rise in price. When price increase demand decrease which is called contraction of demand.
Contraction of demand:
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Contraction of Demand
Price
Quantity Demand
P2
P1
D2
D1
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Demand Curve
The demand curve has a negative slope, consistent with the law of demand.
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Supply Curve
The supply curve has a positive slope, consistent with the law of supply.
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Equilibrium
In economics, an equilibrium is a situation in which: there is no tendency to change, quantity demanded equals quantity supplied,
and the market just clears.
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Equilibrium
Equilibrium occurs at a price of $3 and a quantity of 30 units.
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Shortages and Surpluses
A shortage occurs when quantity demanded exceeds quantity supplied. A shortage leads to increase the price.
A surplus occurs when quantity supplied exceeds quantity demanded. A surplus leads to decrease the price..
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Shortage.
A price is set at $2 resulting in a shortage of 20 units.
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Surplus.
A price is set at $4 resulting in a surplus of 20 units.
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Price Equilibrium:
The equilibrium price the amount that buyers wish to purchase is exactly equal to the amount that supplier are willingly to offer to the market. Simply we can say that the amount at which both buyer and seller are agree. The buyer want to purchase on that price, while supplier is ready to supply that product to the market on that amount.
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Schedule
price Qd Qs 10 80 30 12 70 45 16 60 60 18 50 70 20 40 80
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Diagram 20 18 16
14 12 10 20 40 60 80
100
EPrice
Qd/Qs
E is Equilibrium point
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Explanation
the above schedule and diagram shows various prices of a product and its quantity demand and quantity supply. When the price was 10, the quantity demand of this product was 80 and the supplier supply 30 products to the market. As price increase quantity demand decrease and quantity supply increase. When price increase to 16, at this point the quantity demand and quantity supply both are same, which is call equilibrium price.
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