Demand

Demand

Demand is the amount of a good or service that a consumer is WILLING and ABLE to buy over a SPECIFIED PERIOD OF TIME

Demand and Price

There is usually an inverse relationship between price and quantity demanded.  This can be shown in a demand schedule (table showing the relationship between price and Qd) and a demand curve.

Elasticities of Demand

There are 3 key elasticities of demand:

(1)    Price elasticity of demand: Measures how responsive quantity demand is to a change in the price of the product

(2)    Income elasticity of demand: Measures how responsive demand is to a change in income

(3)    Cross elasticity of demand: Measures how responsive the demand for a good is to the 

change in the price od a related good (substitute or compliment)

Price Elasticity of Demand

There are 3 alternatives.

(1)    Demand is price elastic:  A % change in price leads to a bigger % change in quantity demanded

(2)    Demand is price inelastic: A % change in price leads to a smaller % change in quantity demanded

(3)    Demand has unitary price elasticity of demand. Any % change in price leads to an identical % change in quantity demanded.

What determines whether demand is price elastic or inelastic?

Demand is more likely to be price elastic if:	Demand is more likely to be price inelastic if:
There are lots of substitutes	There are few substitutes
The good is a luxury	The good is a necessity
The good takes up a high proportion of your income	The good takes up a small proportion of your income
The good is durable (lasts a long time)	The good is consumable (gets used up)
The good is heavily branded and has a lot of brand loyalty	The good is not branded

Why is PED information useful?

(1)    It can inform pricing decisions

If a product has price elastic demand, a firm can increase TOTAL REVENUE by putting prices DOWN.

If a product has price inelastic demand, a firm can increase TOTAL REVENUE by putting prices UP

If there is unitary elasticity of demand, changing price has no effect on TOTAL REVENUE and so is pointless

(2)    It can inform stock decisions- for example a firm is told by a wholesaler that the price of tinned salmon has risen.  If the firm know that salmon is price elastic they will foresee a fall in demand and stock less.

Income Elasticity of Demand

There are 3 outcomes:

(1)    Demand is INCOME ELASTIC: A % change in income leads to a bigger % change in demand

(2)    Demand is INCOME INELASTIC: A % change in income leads to a smaller % change in demand

Why is it important?

Knowledge of IED can inform firms about what is likely to happen when there are changes in income.

For example:

(a)    A firm knows that it produces an INCOME ELASTIC good or service.  If incomes fall (during a recession) they may predict a downturn in demand and attempt to move into other markets- for example producing inferior goods or income inelastic normal goods

(b)   A firm knows that it produces INCOME INELASTIC good or service.  This firm will not need to be as concerned about changes in income levels

Cross Elasticity of Demand: Why is it important?

There are 3 alternatives:

(1)    Demand is CROSS ELASTIC: A % change in the price of a compliment or substitute leads to a bigger % change in the demand for our good.  This is likely to happen when it is a very close compliment/substitute

(2)    Demand is CROSS INELASTIC: A % change in the price of a compliment or substitute leads to a smaller % change in the demand for our good.  This is likely to happen when the goods are linked but not that closely (or there is strong brand loyalty in place)

Knowledge of CED can alert a firm to how concerned they need to be about changes in the price of related products and how they might adapt to this.

Examples

(1)    McDonalds know that there is cross elastic demand between Big Macs and Whoppers.  If the price of Whoppers falls, McDonalds can predict a fall in demand for Big Macs.  They will have to respond- either by cutting the price of Big Macs or trying other offers and promotional deals

(2)    HMV stock Wiis and Wii games.  They know that the 2 have very cross elastic demand.  If they know that the price of Wiis is going to fall, they can predict a big rise in the demand for Wiis AND Wii games.  This might make them stock more of both products.  They may also devise promotional offers that take advantage of the link between the products.