2. Demand Theory and
Its Implications In
Managerial Economics
Group
Members
Anam Arif
MB-12-03
Omer Shahzad
MB-12-08
3.
4. Demand is the basis of all productive
activities. Demand theory is an economic
theory that concerns the relationship between
the demand for goods and their prices; it
forms the core of microeconomics.
The generation of demand can be pictorically
shown as below,
NEED
WANT
DEMAND
6. Consumer Demand Theory
Individual Consumer’s Demand
QdX = f(PX, I, PY, T)
QdX = Quantity demanded of commodity X by an individual per time period
PX
= Price per unit of commodity X
I
= Consumer’s income
PY
= Price of related (substitute or complementary) commodity
T
= Tastes of the consumer
7. Consumer Demand Theory
Goods
Inferior Goods
A good that decreases in
demand when consumer
income rises.
Normal Goods
Goods for which demand
increases when income
increases, and falls when
income decreases but
price remains constant.
Substitutes
A product or service that
satisfies the need of a
consumer that another
product or service fulfills.
9. Law of Demand
The law of demand states that the quantity demanded
and the price of a commodity are inversely
related, other things remaining constant. If
the income of the consumer, prices of the
related goods, and preferences of the consumer remain
unchanged, then the change in quantity of good
demanded by the consumer will be negatively
correlated to the change in the price of the good.
10. Law of Demand
There is an inverse relationship between the price
of a good and the quantity of the good demanded
per time period.
Substitution Effect
Income Effect
11. Law of Demand
Income Effect
When price of a commodity falls then the individual can purchase
more units of that commodity, thus quantity demanded for that
commodity increases.
Substitution Effect
When price of a commodity falls, the quantity demanded for that
product increases because the individual substitutes in
consumption the product with its substitutes.
14. Individual to Market Demand
Market Demand Function
QDX = f(PX, N, I, PY, T)
QDX = Quantity demanded of commodity X
PX
= Price per unit of commodity X
N
= Number of consumers on the market
I
= Consumer income
PY =
T
Price of related (substitute or complementary) commodity
= Consumer tastes
15. Individual to Market Demand
Bandwagon Effect
People tend to purchase a commodity which others are using or in
order to follow the fashion.
Snob Effect
Situation where the demand for a product by a high income
segment varies inversely with its demand by the lower income
segment.
16. Demand Faced by a Firm
Market Structure
Monopoly
Perfect Competition
Oligopoly
Monopolistic Competition
17. Demand Faced by a Firm
Monopoly
Firm is sole producer of
commodity
No substitutes
Total control on price
A rare case bound with
government regulations
Examples are local telephone,
electricity, public transport.
Perfect Competition
Large number of firms
Identical products
No control on price
A rare case
Examples are farmers selling
wheat or rice or sugar-cane
18. Demand Faced by a Firm
Oligopoly
Firms producing
homogeneous or standardized
products like cement
Firms producing
heterogeneous or
differentiated products like
soft drinks
Examples are firms in
production sector of the
economy
Monopolistic Competition
Involves elements of
monopoly and perfect
competition
Firm has somehow control
over price
Examples are firms in service
sector like gasoline stations or
barber shops
19. Demand Faced by a Firm
Type of Good
Durable Goods
Nondurable Goods
Producers’ Goods - Derived Demand
20. Demand Faced by a Firm
Durable Goods
Non-Durable Goods
Goods that provide services
not only during the year when
they are purchased but also in
following years
Goods that cannot be stored
and can be used within a year
Firm faces a more volatile or
unstable demand
Examples are
automobiles, electric
appliances
Firm faces a stable demand
Examples are food, cosmetics
and cleaning products
21. Demand Faced by a Firm
Non-Durable Goods
Producer’s Goods
Goods that cannot be stored
and can be used within a year
Goods, such as raw materials
and tools, used to make
consumer goods
Firm faces a stable demand
Examples are food, cosmetics
and cleaning products
The demand for such goods is
derived demand because it
depends upon the demand for
goods and services it sells
Firm’s demand for producers
goods is also more volatile and
unstable
22. Linear Demand Function
QX = a0 + a1PX + a2N + a3I + a4PY + a5T + …….
QX =
Quantity demanded of commodity X faced by the firm
PX
= Price of commodity X
I
= Consumer’s income
PY
= Price of related (substitute or complementary) commodity
T
= Tastes of the consumer
a
=
Co-efficient estimated by the regression analysis
23.
24. Price Elasticity of Demand
A measure of the relationship between a change in the
quantity demanded of a particular good and a change in
its price. Price elasticity of demand is a term in
economics often used when discussing price sensitivity.
The formula for calculating price elasticity of demand is:
25. Price Elasticity of Demand
Price
Elasticity of
Demand
Point Price
Elasticity of
Demand
Arc Price
Elasticity of
Demand
26. Price Elasticity of Demand
Point Definition
Linear Function
Q /Q
P/P
EP
EP
a1
Q P
P Q
P
Q
31. Determinants of Price Elasticity of
Demand
Demand for a commodity will be more elastic if:
It has many close substitutes
It is narrowly defined
More time is available to adjust to a price change
32. Determinants of Price Elasticity of
Demand
Demand for a commodity will be less elastic if:
It has few substitutes
It is broadly defined
Less time is available to adjust to a price change
