3/21/2012

1

�� Meaning of DemandMeaning of Demand

�� Individual and Market Demand ScheduleIndividual and Market Demand Schedule

�� Law of DemandLaw of Demand

�� Shape of Demand CurveShape of Demand Curve

�� Elasticity of demand Elasticity of demand ––

�� Measurement, Measurement,

�� Affecting Factors, Practical importanceAffecting Factors, Practical importance

Unit Unit –– IIII Engineering EconomicsEngineering Economics

Sachin Pourush

DEMAND… MeaningDEMAND… Meaning

Sachin Pourush

Demand == Desire to buy

++++ Ability to pay

++++ Willingness to pay

� Backed up by adequate Pu r c ha s i ng Power

� Always at a P r i ce

� Always be expressed in terms of specific Quan t i t y

� Related to T ime

Demand… definitionDemand… definition

� The demand for a particular good is the amount thatwill be purchased at a given price and at a given time.

- Veera Anstey

� The demand for anything, at a given price, is theamount of it which will be bought per unit of time atthat price.

- Benhaur

� Demand is defined as the amount of commodity orservice bought per unit of time at a given price.

- EdwardSachin Pourush

Markets and Prices

The Circular Flow Model The Circular Flow Model

Input Markets

Product Markets

HouseholdsFirms

Inputs Inputs

ProductsProducts

>

<

Income

Rev

Exp

Exp

Sachin Pourush

Characteristics of DemandCharacteristics of Demand

� It is expressed in numbers rather approximation

� Its backed up by ability to pay

� Demand must mean demand per unit of time means quantity demanded is a flow (e.g. 1Mn Oranges/week)

� Demand is always in a market

Sachin Pourush

Determinants of DemandDeterminants of Demand

� Price of the Commodity (P)

� Price of related commodity (Pr)

� Price expectation in future (Pe)

� Taste & preference (T)

� Income of consumer (Y)

� Individual-specific or environmental factors (S)

Mathematically,

Dx = ffff (P, Pr, Pe, T, Y, S)

Demand Function

Sachin Pourush

3/21/2012

2

Few other Determinants of DemandFew other Determinants of Demand

� Income distribution

� Wealth distribution

� Population size

� Population age distribution

� The interest rate

Sachin Pourush

Demand FunctionDemand Function

Demand is a function of various factors like:

PricePrice

Price ExpectedPrice

Expected

Taste & PreferenceTaste & Preference

Price of related commodity

Price of related commodity

Income LevelIncome Level

FunctionsFunctions

Sachin Pourush

Types of DemandTypes of Demand

� Price Demand*

� Cross Demand*

� Individual Demand & Market Demand

� Income Demand*

� Long run or Short run Demand

� Industry or Company Demand

Sachin Pourush

Price DemandPrice Demand

� The relationship between the price and demand of a commodity, other things remains constant

Mathematically,

Dx = ffff (Px)

Demand

70 9 11 1513 17

2.00

1.75

1.50

1.25

1.00

0.75

0.50

As price rises, the quantity demanded falls

Sachin Pourush

Income DemandIncome Demand

� The relationship between income of the consumer and the quantity demanded of a commodity, other things being equal

Mathematically,

Dx = ffff (Y)

Demand

70 9 11 1513 17

2.00

1.75

1.50

1.25

1.00

0.75

0.50

As income rises, the quantity demanded rises

Sachin Pourush

Cross DemandCross Demand

� The demand derived from the relation between theprice of related commodity (substitute orcomplementary) and the quantity demanded

Mathematically,

Dx = ffff (Ps)

Demand

70 9 11 1513 17

2.00

1.75

1.50

1.25

1.00

0.75

0.50

Fall in price of one commodity raises the demand for other

Sachin Pourush

3/21/2012

3

Cross DemandCross Demand

� The demand derived from the relation between theprice of related commodity (substitute orcomplementary) and the quantity demanded

Mathematically,

Dx = ffff (Pc)

Demand

70 9 11 1513 17

2.00

1.75

1.50

1.25

1.00

0.75

0.50

With fall in price of good, demand for complementary good falls

Sachin Pourush

� Demand Schedule is one wayof showing the relationshipbetween quantity demanded& price.

OR

� A series of prices placed inascending / descending orderwith corresponding quantities.

� It is a numerical tabulation

that shows the quantity thatwill be demanded at someselected price.

7.1

7.5

8.1

8.9

10.0

11.5

14.2

Price of coffee beans (per Rupee)

Quantity of coffee beans demanded

1.75

1.50

1.25

1.00

0.75

0.50

2.00

Demand Schedule for Coffee Beans

Demand ScheduleDemand Schedule

� Analyzing given demandschedule for Alice, who often eatsCoffee beans in her breakfast,living her own, we can say:

� She often keeps an eye on theprice i.o.t to trade-off itsconsumption within her income.

� She increases her consumptionwhen the price get lower andvice-versa

7.1

7.5

8.1

8.9

10.0

11.5

14.2

Price of coffee beans (per Pound)

Quantity of coffee beans demanded(per gallon)

1.75

1.50

1.25

1.00

0.75

0.50

$ 2.00

Demand Schedule for Coffee Beans

Demand ScheduleDemand Schedule Types of Demand ScheduleTypes of Demand Schedule

� Individual Demand Schedule

A schedule or a list of various quantities of acommodity which an individual consumer purchasesat different prices in market

� Market Demand Schedule

A schedule which represents quantities of acommodity which all consumers will buy at allpossible prices at a given moment.

Sachin Pourush

Individual Demand ScheduleIndividual Demand Schedule

A schedule or a list of various quantities of acommodity which an individual consumer purchases atdifferent prices in market

Price of Milk per Kg.

(in Rupees)

Quantity Demanded by Jena

(in Kg.)

5 1

4 2

3 3

2 4

1 5Sachin Pourush

� It is a graph of the individualdemand schedule

� It shows how much of a consumerwant to buy at any given priceand,

� Alternatively, it shows how mucha consumer is willing to pay foreach unit of a good.

Individual Demand CurveIndividual Demand Curve

20 3 4 5

6

5

4

3

2

1

Quantity of coffee beans (billions of pounds)

1

Sachin Pourush

3/21/2012

4

A schedule which represents quantities of a commoditywhich all consumers will buy at all possible prices at agiven moment.

Symbolically,

DM= DA + DB + … + Dn

Market Demand Schedule

Price of Milk ($) Demand of Zena Demand of Kane Market Demand

5 1 2 1 + 2 = 3

4 2 3 2 + 3 = 5

3 3 4 3 + 4 = 7

2 4 5 4 + 5 = 9

1 5 6 5 + 6 = 11Sachin Pourush

The market demand curve is the horizontal sum of the individualdemand curves of all consumers in that market.

DDarla DDino

0 0 10 203020 0

$2

1

$2

1

$2

1

30 40 50

DMarket

(a) Zena’s Individual Demand Curve

(b) Kane’s Individual Demand Curve

(c) Market Demand Curve

Price of

coffee beans (per pound)

Price of

coffee beans (per pound)

Price of

coffee beans (per pound)

Quantity of coffee beans

(pounds)

Quantity of coffee beans

(pounds)Quantity of coffee beans

(pounds)

Market Demand Curve

Sachin Pourush

Definitions of Law of Demand

� The law of demand states that amount demandedincreases with a fall in price and diminishes with a rise inprice.

� Marshall

� Law of demand states that people will buy more at lowerprices and buy less at higher prices, ceteris paribus, (orother things remaining the same).

� Samuelson

� Usually a larger quantity of a commodity will bedemanded at a lower price that a higher price.

� Benham

Sachin Pourush

Law of Demand… With an Example

� Analyzing given demandschedule for Alice, whooften eats Coffee beans inher breakfast, living herown, we can say:

� She increases herconsumption when the priceget lower and vice-versa

� She often keeps an eye onthe price i.o.t to trade-offits consumption within herincome.

7.1

7.5

8.1

8.9

10.0

11.5

14.2

Price of coffee beans (per Rupee)

Quantity of coffee beans demanded

1.75

1.50

1.25

1.00

0.75

0.50

2.00

Demand Schedule for Coffee Beans

Sachin Pourush

A demand curve is a graph of the demand schedule; it shows how much of a good consumers want to buy at any given price and, alternatively, it shows how much a consumer is willing to pay for each unit of a good.

(The curve below is interpolated from 7 demand points.)

70 9 11 1513 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50

Price of coffee bean (per gallon)

Quantity of coffee beans (billions of pounds)

Demand curve, D

As price rises, the quantity

demanded falls

Alice’s Demand CurveAlice’s Demand Curve

Sachin Pourush

Features of Law of DemandFeatures of Law of Demand

� There is an inverse relationship between price andquantity demanded.

� Demand is a dependent variable over theindependent variable Price

� It is merely a qualitative statement. As such it doesnot indicate quantitative changes in price anddemand.

� Generally, the demand curve slopes downwardsfrom left to right.

Sachin Pourush

3/21/2012

5

Exceptions To The Law of Demand

With fa l l in price, demand fa l ls & v ice -versa

� Giffen’s Paradox

� Veblen’s Effect

� Fear of Shortage

� Fear of Future Rise In Price

� Speculation

� Conspicuous Consumption

� Emergencies

� Ignorance &

� Necessaries

People tend to switch towards superior goodsPeople tend to switch towards superior goods

Demand of goods portraying status symbolDemand of goods portraying status symbol

Anticipating future shortage, people purchase moreAnticipating future shortage, people purchase more

Expecting rise or fall in pricesExpecting rise or fall in prices

Special uses in modern lifestyleSpecial uses in modern lifestyle

Sachin Pourush

Why The Curve is Downward Sloped

� Law of diminishing marginal utility

� High level of consumption, when price is low

� New consumers enter to the market of a product

� Fall in price of a superior good leads to rise in ‘Real

Income’ of the consumer

� ‘Substitution Effect’ in case of inferior good

Sachin Pourush

Elasticity of Demand

� An important aspect of a product's demand curve ishow much the quantity demanded changes when theprice changes. The economic measure of this responseis the price elasticity of demand.

� Simply, It is a calculable change in the quantitydemanded due to a relative change in anydeterminant of demand.

Sachin Pourush

Elasticity of Demand

� Elasticity is a measure of responsiveness of onevariable to change in other.

� Marshall

� The elasticity of demand measures theresponsiveness of the quantity demanded of agood, to change in its price, price of other goodsand changes in the consumer’s income.

� Dooley

Sachin Pourush

Elasticity of Demand… kinds

� Price Elasticity

� Income Elasticity

� Cross Elasticity

� Substitution Elasticity

� Complementary Elasticity

Sachin Pourush

EpEp= = Percentage Change In Quantity Demanded

Percentage Change in Price

The Mathematical Representation of Elasticity

Elasticity =%∆Q

%∆P=

∆Q

∆P

Q

P

Because the demand curve is downward sloping and the supply curve is upward sloping the elasticity of demand is NEGATIVE and the elasticity of supply is POSITIVE.

Often these signs are implicit and ignored.

Sachin Pourush

3/21/2012

6

Demand Elasticity… Labels

� Perfectly elastic (e=∞)

� Relatively elastic (e<1)

� Perfectly inelastic (e=o)

� Relatively inelastic (e>1)

� Unitary elastic (e=1)

Sachin Pourush

Price �

Quantity �

� Elastic : the condition of demand when thepercentage change in quantity is larger thanthe percentage change in price

� Inelastic: the condition of demand when thepercentage change in quantity is smaller thanthe percentage change in price

� Unitary Elastic: the condition of demand whenthe percentage change in quantity is equal tothe percentage change in price

Demand Elasticity… Labels

Sachin Pourush

Elasticity… Quick wickElasticity… Quick wick

� Elasticity: the responsiveness of quantity to a changein another variable

� Price Elasticity of Demand: the responsiveness ofquantity demanded to a change in price

� Price Elasticity of Supply: the responsiveness ofquantity supplied to a change in price

� Income Elasticity of Demand: the responsiveness ofquantity demanded to a change in income

� Cross Price Elasticity of Demand: the responsivenessof quantity demanded of one good to a change inthe price of another good

Sachin Pourush

Demand Elasticity… ExampleDemand Elasticity… Example

If a 2% increase in price of Chairs resulted in a 1% decrease in quantity demanded,

the price elasticity of demand would be equal to approximately 0.5

because,EpEp= = Percentage Change In Quantity Demanded

Percentage Change in Price

thus,

EpEp= = 1%

2%=0.5 OR – 0.5

Sachin Pourush

Measurement of ElasticityMeasurement of Elasticity

Sachin Pourush

� Point Method

� Arc Method

� Total Expenditure/ Total Outlay Method

Graphica l MethodsGraph ica l Methods

Determinants of ElasticityDeterminants of Elasticity

� Number and Closeness of Substitutes� The more alternatives you have the less likely you are to payhigh prices for a good and the more likely you are to settle forsomething that will do.

� Time horizon

� Variants of use

� Income of consumer

� Proportion of income spent in the consumption

� Necessities versus Luxuries

Sachin Pourush

3/21/2012

7

Practical Importance of ElasticityPractical Importance of Elasticity

� Elasticity enables a producer to answer:

� "If I lower the price of my product, how much more will Isell?"

� "If I raise the price, how much less will I sell?"

� "If we learn that a resource is becoming scarce, willpeople scramble to acquire it?"

Sachin Pourush

Applications of ElasticityApplications of Elasticity

Sachin Pourush

� Incidence of Indirect Taxation

� Distribution of wealth

� Effect of changing price on firm revenue.

� Income elasticity – as an indicator of industry health,future consumption patterns and as a guide to firmsinvestment decisions.

� Effect of international trade & terms of trade effects.

Production

Factors of production

Law of Variable Proportion

Law of Returns to Scale

Internal & External Economies/ Diseconomies of Scale

Diseconomies of Scale

Unit Unit –– II Engineering EconomicsII Engineering EconomicsChapter – 2

Sachin Pourush

ProductionProduction

Sachin Pourush

� Production is the act of creating 'use', 'value' or'utility' that can satisfy a want or need.

� Any effort directed toward the realization of adesired product or service is a "productive" effort.

� The performance of such act is production.

Ways of Creating UtilityWays of Creating Utility

Sachin Pourush

� Usage UtilityTransforming to a usable form (Transforming Cotton into Mattress)

� Place utilityProviding things at place where you need it

(Selling Packaged Drinking Water)

� Time utilityProviding things on time when you need it(e-Selling – Selling product over internet / TV; e-reservation)

� Service utilityAdding service to same product

(Insurance, Mobile operator Services)

Importance of ProductionImportance of Production

Sachin Pourush

� Improves standard of living of people

� Let consumers satisfy their need / wants

� Enables firms to generate income

� Creates national wealth

� Generates revenue to the government

3/21/2012

8

Factors Affecting ProductionFactors Affecting Production

Sachin Pourush

� Resource availability

� Technology available

� Banking and Credit policies

� Government policies

� Socio-cultural Factors

� Economic situation

Factors / Means of ProductionFactors / Means of Production

Sachin Pourush

� All the resources used in production

� Physical, non-human inputs used in production (e.g.factories, machines, tools, stationary, phone, lightsetc)

� Significant Factors:

� Land (L)

� Labor (N)

� Capital (K)

�Organization (O)

LandLand

Sachin Pourush

� The whole of the materials and forces which naturegives freely for man’s aid in land and water, in air, lightand heat.

- Marshall

� In economics, any space virtual/ real partially orwholly occupied for the establishing business

� It can be air, ocean, earth surface.

Land Land -- FeaturesFeatures

Sachin Pourush

� Available in abundance yet scarce

� Indestructible

� Immobile

� Differs in variety

� Passive factor

� Basis of all other factors

LaborLabor

Sachin Pourush

� By labor is meant the economic work of man, whetherwith the hand or with the head.

- Marshall

� All the physical or mental efforts made by anindividual with a view to earn a reward.

� It includes skilled & unskilled, technical & non-technical, ordinary & managerial.

Labor Labor -- FeaturesFeatures

Sachin Pourush

� Mobile

� Active factor

� Divisible on the basis of functional specialization

� Inseparable from worker

� Productivity can be increased, money is motivation

3/21/2012

9

CapitalCapital

Sachin Pourush

� Capital consists of those kinds of wealth, other thanfree gifts of nature, which yield income.

- Marshall

� All the man-made inputs given to the business

� It appears in various forms like plant andmachinery, tools, buildings, roads, dams, bridges,means of transportation and communication.

Capital Capital -- FeaturesFeatures

Sachin Pourush

� Result of saving to earning ratio

� Secondary factor

� Mobility

Enterprise / EntrepreneurEnterprise / Entrepreneur

Sachin Pourush

� An entrepreneur is a person who performs dual functionof risk-taking and control.

- F. H. Knight

� An agent who unites all factors of production –land, labor and capital

� Schumpeter considers entrepreneur as an innovator

Entrepreneur Entrepreneur -- FeaturesFeatures

Sachin Pourush

� Purposeful activity

� Risk element

� Dynamic process

� Coordination of resources

Factors ClassificationFactors Classification

Sachin Pourush

� Fixed factor inputsInputs that remain fixed for a certain period of time irrespective of scale of productione.g. Land, Building, Machineries etc.

� Variable factor inputsAll the factor inputs that varies as the scale of production variese.g. Raw material, electricity, other bills etc.