IKT434 Topics in Economics

Managerial Economics: Demand Analysis

Demand
Demand is the quantity of good and services that customers are willing and able purchase during a specified period under a given set of economic conditions. The period here could be an hour, a day, a month, or a year. The conditions to be considered include the price of good, consumers income, the price of the related goods, consumers preferences, advertising expenditures and so on. The amount of the product that the costumers are willing to by, or the demand, depends on these factors. There are two types of demand. The first of these is called direct demand. This model of demand analysis individual demand for goods and services that directly satisfy consumers desires. The prime determinant of direct demand is the utility gained by consumption of goods and services. Consumers budget, product characteristics, individuals preferences are all important determinants of direct demand. The other type of demand is called derived demand. Derived demand is the demand resulting from the need to provide the final goods and services to the consumers. Intermediate goods, office machines are examples of derived demand. An other good example is mortgage credit. Mortgage credit demand is not demanded directly, but derived from the demand for housing.

IKT434 Topics in Economics

Market demand function

The market demand function for a product is a function showing the relation between the quantity demanded and the factors affecting the quantity of demand. A demand function for the good X can be expressed as follows: Quantity of product X demanded = Q x = f (the price of X, prices of related goods, expectations of price changes, income, preferences, advertising expenditures and so on. ) For use in managerial decision making, the relation between quantity of demand and each demand determining variable must be specified. To illustrate this, the demand function for automobile industry is

Q = a 1 P + a 2 PI + a 3 I + a 4 POP + a 5 i + a 6 A
This equation states that the number of new domestic automobiles demanded during a given year (in millions), Q, is a linear function of the average price of new domestic cars (in $), P, th average price of new import cars, PI, disposable income per household (in $), population (POP), average interest rate on car loans (in %), i, and industry advertising expenditures (in million $). Assume that the parameters of this demand function is know and shown in the following equation:

IKT434 Topics in Economics

Q = - 500 P + 210 Px + 200 I + 20.000 POP + 1.000.000 i + 600 A

Q : the number of new domestic automobiles demanded P : the average price of new domestic cars (in $), Px : the average price of luxury cars, I : disposable income per household (in $), POP : population i : average interest rate on car loans (in %), A : industry advertising expenditures (in million $). Interpretation of the coefficients:
dQ = - 500 (automobile demand decrease by 500 for each 1$ d

increase)

dQ = 200 dPX

(a $1 increase in the average price of luxury cars, increases demand for the domestic cars by 200.)

Demand Curve
The demand function specifies the relation between the quantity demanded and all factors that determine demand. But the demand curve expresses the relation between the price of a product and the quantity demanded, holding constant all the other factors affecting demand. This can be written as follows:

IKT434 Topics in Economics

Q = f (P)

Q : demand P : price

To illustrate this, consider the automobile demand function example above. Assuming that luxury car prices, income, population, interest rate and advertising expenditure are all held constant, the relation between the quantity demanded for domestic cars and price expressed as; Q = 20.500.000 500 P Q = f (P)

In our analysis, what we usually do is to express price as a function of demand. P = f (Q). This is called inverse demand function. The above equation then becomes; P = 41.000 0.002 Q
Average oto price
45 40 35 30 25 20 15 10 5 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

inverse demand function.

IKT434 Topics in Economics

Change in the quantity demanded; is defined as the movement along a single demand curve. This movement reflects change in price and quantity.
Average oto price
45 40 35 30 25 20 15 10 5 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

Shift in demand; is the switch from one demand curve to another. Shift in demand reflects a change in one or more nonprice variables affecting demand. Example: change in interest rate.
Average oto price
45 40 35 30 25 20

%6
15 10 5

%8 %10

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

IKT434 Topics in Economics

As seen the figure, a change in interest rate shifts demand for automobile. A decrease in interest rate increases automobile demand at the same price.