105 me consumer behaviour demand

8/4/2019 105 ME Consumer Behaviour Demand

1/72

Consumer Behavior and

Demand Analysis


2/72

Consumer Behavior

Any market has two sides:

The demand: resulting from the behavior of thebuyers

in the market;

and the supply: resulting from the behavior of the

sellers in the market.

The behavior of either side can be described with

appropriate curves:The Demand Curve and the Supply Curve.

Why do people demand goods and services? Receive satisfaction or pleasure from consuming the good.

Economists terms this satisfaction utility


3/72

Consumer

Our basic assumptions about a rational consumer:

Consumers are utility maximizers

Consumers prefer more of a good (thing) to less of it.

Facing choices X and Y, a consumer would either prefer X toY or Y to X, or would be indifferent between them.

Transitivity: If a consumer prefers X to Y and Y to Z, we

conclude he/she prefers X to Z

Diminishing marginal utility: As more and more of good isconsumed by a consumer, ceteris paribus, beyond a certain

point the utility of each additional unit starts to fall.


4/72

Utility

The value a consumer places on a unit of a good or service depends on the

pleasure or satisfaction he or she expects to derive form having or

consuming it at the point of making a consumption (consumer) choice.

In economics the satisfaction or pleasure consumers derive from theconsumption of consumer goods is called utility.

Consumers, however, cannot have every thing they wish to have.Consumers choices are constrained by their incomes.

Within the limits of their incomes, consumers make their consumptionchoices by evaluating and comparing consumer goods with regard totheir utilities.


5/72

Approaches to consumer behavior

Cardinal Approach

Traditional theory (By Marshall)

Examines consumer behavior on the basis of utility

consideration.

Utility in terms of number

Ordinal approach

Revealed preference theory

Modern Theory (Hicks)

Ranking of options for a particular commodity

Indifference Curve Analysis


6/72

Cardinal Approach

Law of Diminishing marginal Utility

Other things remain the same, as a consumer

increases his consumption of goods, the Marginal

Utility eventually starts declining.

If MU diminishes then demand will also decrease.


7/72

TU, MU and profit

Total Utility (TU) - relates consumption of a good to

the utility derived from consuming a good. It is the

sum of marginal utilities. (This could be many units

of a good)

Marginal Utility (MU) - the change in total utility

when consumption of a good changes by one unit.

MU = DTU /D Q consumed of a good


8/72

Utility Schedule

Quantity Total Utility Marginal Utility

2 8 0

3 18 10

4 26 8

5 31 5

6 33 27 33 0

8 32 -1


9/72

Diagram of TU and MU

-5

0

5

10

15

20

25

30

35

Quantity

TU

andMU Marginal Utility

Total Utility


10/72

Some facts of life:

Limited income

Opportunity cost of making a choice:

Buying a unit will leave the consumer withless money to buy other things.

In fact, consumers compare the (expected)

utility derived from one additional moneyspent on one good to the utility derived fromone additional money spent on another good.


11/72

Findings

Shape of MU

Eventually downward sloping

Law of diminishing marginal utility

Positive always

Rational behavior Consumer only purchases a good if they get some

positive utility from it.


12/72

Findings contd

Shape of TU

Positive slope

Consumer only purchases a good if gets some

positive amount of utility (rational behavior)

Slope gets flatter as Q increases Law of diminishing marginal utility


13/72

Consumer surplus

Money measure of the value the consumers getfrom a good or service, net of the amount paid.

Consumer Surplus - the difference between the price

buyers pay for a good and the maximum amount theywould have paid for the good.

Example: Im willing to pay $6 for a case of soda Soda is on sale for $5 a case

Consumer surplus = $1


14/72

Consumer surplus

S

DQ

P

0

$5

31 2

$9

$7

This is the Consumer

Surplus for the

second case of soda


15/72

Ordinal utility

Indifference Curve

A curve that defines the combinations of 2 or

more goods that give a consumer the same

level of satisfaction.

Curves further from origin represent higherutility levels


16/72

Assumptions of Indifference curve

Indifference curve analysis is based on the following assumptions:

1. Transitivity: It is assumed that the combinations are continuous toform a curve. The combinations between two tested sets are given.

2. Ordinality: The indifference curve analysis considers ordinal measure

of utility. That is utility is compared but not qualified.2. Rationality: The consumer is rational. He always prefers highersatisfaction to the lower and he knows all the combinations giving himsame satisfaction or different satisfactions.

3. Convexity: A convex indifference curve represents the consumer

behavior. The convex IC shows the utility behavior with out actuallymeasuring utility in cardinal terms.

4. Scale of preference: On a series of indifference curves the consumerhas a preference increases from low to high. The consumer alwaysprefers higher satisfaction to lower. This is called the scale ofpreference.


17/72

Properties of Indifference curve

Indifference curve towards axis represents

lower level of satisfaction


18/72

Properties....

Indifference curve never touches the axis


19/72

IC is a downward sloping curve


20/72

On a IC Marginal rate of substitution decreases


21/72

IC is convex to the origin


22/72

IC curves need not to be parallel

IC curves do not intersect.


23/72

Combinations Mangoes Oranges

1 10 2

2 8 3

3 6 4

4 4 5

5 2 6


24/72

Budget line

The amount of goods a consumer can buy is

constrained by the income. This budgetary

constraint can be shown by the budget line.


25/72

A (Pm*Qm) B (Po*Qo) A+B (Total

Income)

20*5 10*0 100

20*4 10*1 100

20*3 10*2 100

20*2 10*3 100

20*1 10*4 100


26/72

Consumer equillibrium

The consumer is in the equilibrium where the indifference curveis tangent to the budget line.

There are two conditions of consumer equilibrium

a. Necessary Condition: Tangency is a necessary condition. It iscase of optimizing satisfaction. In the diagram is a necessarycondition. Yet it is not the equilibrium.

b. Sufficient condition: Tangency + convexity is sufficientcondition. Tangency represents mathematical optimization andconvexity denotes consumer behavior. In the diagram E2 isnecessary condition. It fulfills tangency as well as convexity.


27/72

Consumer surplus

Anything above the consumer equilibrium but

with in the budget line is consumer surplus.


28/72

DEMAND ANALYSIS


29/72

Demand defined

Demand is the willingness and ability ofbuyers to purchase different quantities of agood, at different prices, during a specific time

period.

Both willingness and ability must be present; if

either is missing, there is no demand. The demand curve is just the description of

the relationship between quantity and price.


30/72

Determinants of Demand

Income

Preferences

Prices of related goods Number of buyers

Future price


31/72

Income

As a persons income changes, he or she may

buy more or less of a certain good.

If a persons income and demand change in thesame direction, the good is a normal good.

If income and demand go in opposite

directions, the good is an inferior good. If demand does not change even though

income does, the good is a neutral good.


32/72

Preferences

Changes in preferences cause changes in

demand.


33/72

Prices of Related Goods

When two goods are substitutes, the demand for one

moves in the same direction as the price of the other.

If the price of coffee increases, the demand for tea

increases as people substitute tea for the higher-pricedcoffee.

When two goods are complements, the demand for

one moves in the opposite direction of the price of the

other. As the price of tennis rackets rises, the demand for tennis

balls decreases.


34/72

Number of Buyers

A change in the number of buyers, either an

increase or a decrease, can change demand.


35/72

Future Price

Buyers expectations of future prices can cause

them to buy now or wait to buy. Both actions

affect current demand.

The only factor that affects quantity demanded

is price.


36/72

Other determinants

Availability of substitutes

Share of consumers budget spent on the good.

A matter of time Some elasticity estimates.


37/72

Demand Function

A table, graph, or an equation that shows how quantitydemanded is related to product price, holding constantthe five other variables that influence demand.

A demand function can be expressed as:

Which means that the quantity demanded is a function

of the price of the good, holding all other variablesconstant.

It is expressed in the form of a linear demand equation.


38/72

Demand function contd

Where Q = Quantity purchased of a good or service

P = Price of the good or service

M = Consumers income Pr = Prices of related goods

N = Number of buyers


39/72

Law of demand

The quantity purchased of a good or

service is inversely related to the price,

all other things being equal. Thus, thehigher the price, the smaller the quantity

demanded.

If P then Qd

If P then Qd


40/72

Quantity Demanded vs. Demand

Quantity demanded

The quantities of a good or service that people

will purchase at aspecific price over a given

period of time

Demand

Graph of the total quantities of a good or

service that purchasers will buy atdifferentprices at a given time


41/72

Types of Demand

Individual demand

The quantity of a good or service that an

individual or firm stands ready to buy at

various prices at a given time

Market demand

The sum of the individual demands in the

marketplace


42/72

Demand Curve

AED

1.55

1.50

1.45

1.40

1.35

1.30

1.25

1.20

1.15

1.10

1.05

0 1 2 3 4 5 6 7 8 9 10 11 12 13

Quantity (Number of hours per Day )

Price

per

Hour

D


43/72

Demand Schedule

Price Quantity Demanded

per Pizza per Week (millions)

a $15 8b 12 14

c 9 20

d 6 26

e 3 32


44/72

8 14 20 26 32Millions of pizzas per week

$15

12

9

6

3

0

Price

perpizza

Demand Curve for Pizza

a

b

c

d

e

D


45/72

$12

8

4

1

C

$12

8

4

1 2

B

$12

8

4Price

1 2 3 Pizzas(per week)

A

Individual Demand for Pizzas

dH dB dC


46/72

$12

8

4Price

1 2 3 Pizzas(per week)

(d) Market demand for pizzas

6

Market Demand for Pizzas

dH dB dC D+ + =


47/72

Changes in Demand

Change in Quantity Demanded

Movement along the demand curve that occursbecause the price of the product has changed

Change in DemandChange in the amounts of the product that

would be purchased at the same given prices; ashift in the entire demand curve


48/72

When Demand Changes, the Curve

Shifts

When demand goes up, the demand curve

shifts to the right. (Change in Demand)

When demand goes down, the demand curve

shifts to the left. (Change in Demand)
http://www.pontiac.k12.il.us/academics/socials/documents/ChangeinDemandandQuantityDemanded.pdfhttp://www.pontiac.k12.il.us/academics/socials/documents/ChangeinDemandandQuantityDemanded.pdfhttp://www.pontiac.k12.il.us/academics/socials/documents/ChangeinDemandandQuantityDemanded.pdfhttp://www.pontiac.k12.il.us/academics/socials/documents/ChangeinDemandandQuantityDemanded.pdf


49/72

Elasticity of Demand


50/72

What is Elasticity of Demand?

Elasticity is another term in economics that

sounds more difficult to understand than it

really is.

It measures how a price change affects the

quantity of a particular good that people want

to buy.

Wh t t f l ti it


51/72

What types of elasticity are

there?

Demand for a good can be elastic, inelastic, or

unit-elastic.

Elastic: a price change has a significant impact

on the quantity demanded.

Inelastic: there is a minor change in quantity

demanded when the price changes.

Unit-elastic: the impact of a price change is

neutralthat is, neither major nor minor.

H d fi d t hi h t f


52/72

How do we find out which type of

demand is at work?

In all cases, the type of demand has to do with

the relationship between the percentage change

in quantity demanded and the percentage

change in price.

When we divide the percentage change in

quantity demanded by the percentage change

in price, we get a number that is greater than 1,less than 1, or exactly 1.

Computing the


53/72

Computing the

Elasticity of Demand Elasticity of demandmeasures the percentage

change in quantity demanded divided by

percentage change in price.

Elasticityofdemand

=

Percentage change inquantity demanded

Percentagechange in price

H d fi d t hi h t f


54/72

How do we find out which type of

demand is at work? (cont.)

If the answer to our division problem is greater

than 1, the demand is elastic.

If the answer is less than 1, the demand is

inelastic.

If the answer is exactly 1, the demand is unit-

elastic.

l i i f d


55/72

(b)Quantity/

time

(a)

Quantity/

time

Mythicaldemandcurve

Perfectly inelastic:

An increase in price results in nochange in consumers purchases.The vertical demand curve ismythical as the substitution andincome effects prevent this fromhappening in the real world.


Relatively inelastic:A percent increase in price results

in a smaller % reduction in sales.The demand for cigarettes hasbeen estimated to be highlyinelastic.

Demand forCigarettes

El i i f D d


56/72

(c)

Quantity/time

Unitary elasticity:

The percent change in quantitydemanded due to an increase inprice is equal to the % change inprice. A decreasing sloperesults. Sales revenue (pricetimes quantity) is constant.


Demand curve ofunitary elasticity


57/72

Example :1

Suppose the quantity demanded goes down by

15 percent and the price goes up by 10 percent.

What type of demand do we have?

We divide 15 percent by 10 percent and get

1.5. Since the number is greater than one, the

demand is elastic.


58/72

Example: 2

What if the quantity demanded goes down by 5

percent and the price goes up by 10 percent?

We divide 5 percent by 10 percent and get 0.5.

Since the answer is less than 1, the demand is

inelastic.


59/72

Example: 3

What if the quantity demanded goes down by

10 percent and the price goes up by 10

percent?

We divide 10 percent by 10 percent and get 1.

Obviously 1 is equal to 1, so the demand is

unit-elastic.


60/72

Price elasticity of demand

Price elasticity reveals the responsiveness ofthe amount purchased to a change in price.

P i El i i f D d


61/72

Price Elasticity of Demand Price elasticity reveals the responsiveness of the

amount purchased to a change in price.Price Elasticity

of demand =%DQ

%DP=

% Change inquantity demanded

% Change in Price

2)(

)(

2)(

)(

10

10

10

10

PP

PP

QQ

QQ

=

- or put more simply -

=)()(

)()(

1010

1010

PPPP

QQQQ

P i El i i N i l A li i


62/72

Price Elasticity Numerical Application Suppose Trina bakes specialty cakes. She can sell 50

specialty cakes per week at $7 a cake, or 70 specialtycakes per week at $6 a cake. What is the demand elasticity for Trinas cakes?

%33.33

60

20

2)7050(

)7050(

Percent change in

quantity demanded:Percent changein price:

%38.155.6

1

2)67(

)67(

Price Elasticityof demand

=2)(

)(

2)(

)(

10

10

10

10

PP

PP

QQ

QQ

- Recall -

D t i t f


63/72

Determinants ofPrice Elasticity of Demand Availability ofsubstitutes

When good substitutes for a product are available, arise in price induces many consumers to switch toanother product.

The greater the availability of substitutes,the more elastic demand will be.

Share of total budget expended on product

As the share of the total budget spent on the productincreases, demand is more elastic.

Ti d D d El ti it


64/72

Time and Demand Elasticity If the price of a product increases, consumers

will reduce their consumption by a largeramount in the long run than in the short run.

Thus, demand for most products will be more

elastic in the long run than in the short run. This relationship is sometimes referred to as the

second law of demand.

I El ti it


65/72

Income Elasticity Income elasticityindicates the responsiveness of

a products demand to a change in income.Income Elasticity

of demand =% Change in

quantity demanded

% Change inIncome

Anormal goodis a good with a positive incomeelasticity of demand.

As income expands, the demand for normal goodswill rise.

Goods with a negative income elasticity arecalled inferior goods.

As income expands, the demand forinferior goods will decline.


66/72

What Determines Elasticity of Demand?

Four factors affect the elasticity of demand:

Number of substitutes

Luxuries versus necessities

Percentage of income spent on the good

Time


67/72

Number of Substitutes

When there are few substitutes for a good, the

quantity demanded is unlikely to change much

if the price rises. Therefore, the demand for

the good is likely to be inelastic. When thereare many substitutes for a good, the opposite is

true: the demand tends to be elastic.


68/72

Luxuries versus Necessities

Demand for necessities tends to be inelastic

because people need those goods even if prices

rise.

Demand for luxuries tends to be elasticbecause people will often do without those

goods if prices rise.


69/72

Percentage of Income Spent on the Good

If a good requires a large percentage of a

persons income, demand for it tends to be

elastic.

Demand for goods that require a smallpercentage of a persons income tends to be

inelastic.


70/72

Time

When consumers have little time to respond to

a price change, demand is usually inelastic.

When they have more time to respond, demand

is usually elastic.


71/72

Relationship Between Elasticity and Revenue

Elastic demand and an increase in price lead to

a decrease in total revenue.

Elastic demand and a decrease in price lead to

an increase in total revenue.

Inelastic demand and an increase in price lead

to an increase in total revenue.

Inelastic demand and a decrease in price lead

to a decrease in total revenue.


72/72

Demand Estimation and

Forecasting

105 me consumer behaviour demand

Documents