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Student Publications
Author: Khaiser Ali Shah
Title:
Managerial Economics & Quantitative Techniques
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ATLANTIC INTERNATIONAL UNIVERSITY
Summer 2007 Phase � II
CONTENTS
1. DEVELOPMENT OF MARKET
2. COMPANY PROFILE
3. PRODUCT PROFILE
4. PRODUCTION & SALES
5. MARKET SHARE
6. DEMAND FORCASTING
7. PROSPECTS
8. PROBLEMS
Managerial Economics & Quantitative Techniques
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ATLANTIC INTERNATIONAL UNIVERSITY
Summer 2007 Phase � II
MODULE II - Part I - DEMAND ANALYSIS & ELASTICITY OF DEMAND
Demand is the willingness to buy a commodity and ability to buy it.
Point of equilibrium Px = Mix
Demand is always referred with time & price.
Demand of commodity can be defined as quantity of the commodity at a
particular price
during a given point of time.
* Demand and price are inversely related. Other than price demand
for a commodity
depends upon a host of other factors like:
i.)
income of consumer
ii.)
prices of related commodities
iii.)
taste & preferences
iv.)
expectations regarding future price
v.)
geographical location
vi.)
composition of population etc.
These are the determinants of demand.
*
Price Demand
; Price Demand
i.) Income of consumers
Income and Demand are Directly related.
Income Demand
Income Demand
Managerial Economics & Quantitative Techniques
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Summer 2007 Phase � II
People's purchasing power increases or decreases as case may be.
ii.) Prices of related commodities
a.)
If substitutes of a particular commodity are available in the market
and the price of
the substitute rises, demand for the commodity rises.
Substitute Demand
Substitute Demand
b.)
If complements are available
Complements Demand
BUT
Complements does not always work. For example :
Car Petrol
BUT
Petrol Car X
iii.) Changes in taste & preferences
If something is in fashion, demand for the product is high. If not
in fashion, demand may be
low.
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ATLANTIC INTERNATIONAL UNIVERSITY
Summer 2007 Phase � II
iv.) People's expectation regarding future prices
If expectation of future prices is high, then more demand is there
at present and vice versa.
*
Other than above mentioned determinants, quantity demanded is also
dependant upon
population, composition of population, geographical conditions etc.
For example :
i.)
Population Demand
ii.)
More the male population, greater the demand for Male products
iii.)
Blankets : Price of Blankets doesn't affect Mumbai but Canada is
affected.
Demand Curve
Demand Curve is downward sloping. The factors responsible for
downward sloping demand
curve is as follows :
i.)
Law of Diminishing Return
According to this law every additional unit consumed would give less
and less satisfaction to
the consumer. So the amount of money the consumer is willing to pay
for additional unit of
a commodity becomes lesser and lesser. So consumer will purchase
additional commodity
only when the price is lower. Therefore, more quantity is brought at
a lower price.
ii.)
Income Effect
As the price of the commodity falls, the consumer's real income
increases. His purchasing
power increases. He is in a position to buy more of the given
commodity.
iii.)
Change in the number of consumers
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ATLANTIC INTERNATIONAL UNIVERSITY
Summer 2007 Phase � II
As the commodity becomes cheaper, many more people who couldn't
afford it earlier will be
in a position to buy the commodity. As a result, number of consumers
will increase. Hence,
the demand for a commodity goes up when it's price goes down.
iv.)
Substitution Effect
When the price of a commodity goes up and the substitutes are
cheaper, then the people will
go for commodities which are cheaper. Thus demand for commodity will
go down.
v.)
Diverse use of a commodity
Many commodities can be used for several purposes. When the price is
high, it's use is
restricted to a few applications. When it becomes cheaper, people
can afford to use it in
other ways as well. As a result, demand for a commodity goes up as
price falls.
The Law of Demand
The Law of Demand expressing the inverse relationship between
quantities demanded and
price is valid in most of the situations. But there are some
exceptional situations under which
there may be a direct relationship between price and quantity
demanded.
One of the exceptions is associated with THORESTEIN VEBLER.
According to him, if consumer measures utility of a commodity only
by its price & nothing
else, then they tend to buy more of a commodity at a higher price
and less of it at lower price.
These goods are known as VEBLER'S GOODS. These goods loose their
appeal when price
falls. Therefore, the laws of demand do not apply to these goods,
which are status symbols.
Another exception is associated with ROBERT GIFFEN. He observed that
when the price of
bread was rising in Britain, British workers brought more of bread.
They substituted bread
for meat, because meat was very expensive and unaffordable. Such
goods which are the
basic requirements are known as GIFFEN'S GOODS. For example,
potatoes, bajra etc.,
Managerial Economics & Quantitative Techniques
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ATLANTIC INTERNATIONAL UNIVERSITY
Summer 2007 Phase � II
which are generally consumed by the poor families and a large part
of consumer's income is
spent on these goods. Price effect is negligible.
i. e. P.E. = S.E.+ve < I. E. �ve
But normally,
P.E. = S.E.+ve > I.E.-ve
Where,
S.E. = Substitution Effect &
I.E. = Income Effect may be �ve, +ve.
Laws of Demand do not hold good in the times of EMERGENCIES such as
Flood, Famine,
war etc. This is because of a fear of shortages of goods in future
increase the demand.
People become panicky and buy more amount of goods even at higher
prices.
Laws of Demand does not hold true during the PROSPERITY PHASE and
the
DEPRESSION PHASE. During prosperity, while the prices rise, the
demand for the goods
also keeps rising, because the income of the people is also rising,
during this phase.
On the other hand, during depression, while the prices fall, the
demand of the goods and
services also falls, because during Depression employment and
incomes in the Economy are
low. Thought he prices are affordable, people are not in a position
to buy goods and services.
More over since the prices are falling, people expect a further fall
in prices in future and
therefore, postpone their buying.
So the low of demand does not hold true during phases of prosperity
and depression phases
of the Business cycle.
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ATLANTIC INTERNATIONAL UNIVERSITY
Summer 2007 Phase � II
Boom
Prosperity
Recession
EXTENSION & CONTRACTION OF DEMAND
It refers to increase in quantity demanded or decrease in quantity
demanded with respect to
change in price only.
Other determinants remaining constant, an EXTENSION of demand due to
a fall in price,
there is an increase in demand and vice versa. If the price of a
commodity increases and
demand decreases, it is known as CONTRACTION.
Managerial Economics & Quantitative Techniques
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ATLANTIC INTERNATIONAL UNIVERSITY
Summer 2007 Phase � II
P2
Price
P1
Q1
Q2
Quantity
INCREASE & DECREASE IN DEMAND
When there is a change in quantity demanded due to factors other
than price, it is known as
INCREASE or DECREASE of demand.
In case of Increase in demand, the quantity demanded increases at
same price i. e. at the same
price the consumers are prepared to but more and more. Therefore,
the demand curve shifts
towards the right.
Managerial Economics & Quantitative Techniques
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ATLANTIC INTERNATIONAL UNIVERSITY
Summer 2007 Phase � II
D1
D2
P
Price
Q1
Q3
Quantity
A fall in quantity demanded due to any other factor than price is
known as Decrease in
demand. i. e. at the same price less quantity is demanded. In case
of decrease in demand the
demand curve shifts to the left.
CLASSIFICATION OF DEMAND
Autonomous & Induced demand
Autonomous Demand is that demand which is not tied up with demand
for other goods &
services. It is independent of the use of other goods.
For example : Consumer Goods.
Derived or induced Demand is that demand which is dependent on the
demand for some
other product. It is known also known as derived demand.
Managerial Economics & Quantitative Techniques
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ATLANTIC INTERNATIONAL UNIVERSITY
Summer 2007 Phase � II
For example : Producer Goods. He demand for inputs depends on the
demand for the
finished goods.
Industry or Company Demand
Demand faced by an individual firm is known as company demand. But
demand faced by
several companies producing same commodity (Substance) i. e.
industry is known as
Industry Demand. Company demand is a small percentage of the
Industry Demand.
Individual / Market Demand
Demand for certain products can be studied not only in its totality
but also by breaking it up
in two different segments on the basis of product, use, distribution
channel, age, income etc.
Division of demand into different segments gives rise to the concept
of Market Segment
Demand.
Problems of pricing, distribution etc. fall in the purview of
analysis of market segment.
Demand for the entire market in totality is known as Market Demand.
Study of Sales Forecasting, demand forecasting etc. relate to the
total market.
Demand for Durable & Non-durable Goods
Durable Goods are those goods which are used over a period of time.
They need Present as
well as future demand. They can be consumer or producer goods.
Non-durable goods are those goods which deteriorate in quality with
passage of time and
become non-useable after the initial usage. e.g. Fruits etc. There
are perishable or non-
durable consumer goods. Goods like coal, electricity etc. are
non-durable producer goods.
LONG TERM & SHORT TERM DEMAND
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Summer 2007 Phase � II
Short term demand refers to existing demand which is dependent on
seasonal pattern and
cyclical pattern.
In short term existing buyers will raise the demand of the product,
if price comes down.
Short term demand is a temporary demand.
Long term demand does not depend on seasonal or cyclical situation.
Long term demand
trends are useful to Business firms for investments, inventories and
product planning.
ELASTICITY OF DEMAND
Elasticity of demand refers to the degree of change in quantity
demanded or the degree of
responsiveness of the quantity to a change in any one of the
determinants of demand, the
other determinants remaining constant.
Elasticity of demand may be of following types :
1)
Price Elasticity
2)
Income Elasticity
3)
Cross Elasticity
4)
Promotional Elasticity
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ATLANTIC INTERNATIONAL UNIVERSITY
Summer 2007 Phase � II
Measurement of Price Elasticity
1)
Percentage Method
According to the percentage method, there is a proportionate change
in quantity demanded to
a proportionate change in price.
^ Q
q
ep = _______ = ^ Q x p
^ P ^ P q
p
ep = ^ Q x p
^ P q
The value of Price Elasticity varies from 0 to infinity (0-infinity)
i.) Elasticity will be less than 1, if % change in quantity demanded
is less than the %
change in price.
ii.) Elasticity will be > 1, if the % change in demand is > than the
change in price.
i.e. ep > 1 ; ^ Q > ^ P
q p
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ATLANTIC INTERNATIONAL UNIVERSITY
Summer 2007 Phase � II
iii.) Elasticity will be infinity, when a small change in price will
bring about a very large
change in demand.
i.e. ep = Oo
D
D1
D2
Price
D3
Quantity Demanded
2)
Total Outlay Method
Total outlay refer to the total expenditure of the product. By
knowing the change in total
expenditure due to a change in the price, we can find out the
elasticity of the demand. By
this method we don't get the exact value of elasticity. We can only
say whether
ep = 1 or ep > 1 or ep < 1
ep = 1 : Total expenditure on commodity does not change due to
change in price.
e. g. P = Rs. 5; Q = 100 units
P Rs. 4; Q 125 units
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ATLANTIC INTERNATIONAL UNIVERSITY
Summer 2007 Phase � II
ep > 1 : If a fall in price leads to an increase in total layout or
a rise in price leads
to a decrease in total outlay.
e. g. P = Rs. 5; Q = 100 units 500 units
P = Rs. 4; Q = 140 units 560 units
ep < 1 : If total outlay declines with a fall in price and rises
with a rise in price.
e.g. P = Rs. 5; Q = 100 units 500 units
P Rs. 4; Q 120 units 480 units
Ep>1
Ep=1
Ep<1
3)
Geometric Method
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ATLANTIC INTERNATIONAL UNIVERSITY
Summer 2007 Phase � II
On a straight line demand curve value of elasticity can be measured
by the ratio of cover
segment upon upper segment.
ep = Lower segment
Upper segment
A
L
P
L1
S
P1
M
M1
B
Quantity Demanded
ep = M M 1 x O P (1) (From % method)
P P 1 O M
Therefore : M M 1 = S L 1 ; O P = M L ; P P 1 = S L
Substituting: ep = S L 1 x M L
S L O M (From % method of equation 1)
Therefore : ^ LSL1 === ^ LMB (<LSL1 & <LMB = 900 ; <SL1L & <MBL are
(corresponding angles � by AAA test)
Therefore : ep = M B x M L
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ATLANTIC INTERNATIONAL UNIVERSITY
Summer 2007 Phase � II
M L O M
^ AOB ==== ^ LMB
ep = M B = L M = L B
P L A P A C
= L B = Lower segment
A L Upper segment ( Hence proved )
If the demand curve is a curve and not a straight line, draw the
tangent to the point &
calculate.
4)
Arc Method
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ATLANTIC INTERNATIONAL UNIVERSITY
Summer 2007 Phase � II
The point method can for elasticity can be used only for marginal
changes. Generally, the
change in price is not very small. In that case, we have to measure
elasticity over the
substantial range of the demand curve.
Arc Elasticity (ep) = ^ Q
(Q1 + Q2)
2
^ P
(P1 + P2)
2
ep = ^ Q x P1 + P2
^ P Q1 + Q2
DETERMINANTS OF ELASTICITY OF DEMAND
Elasticity of demand depends on nature of commodity. If the
commodity is a necessity, a
change in price will not lead to a change in demand for that
product. Similarly, goods with
the status symbol also have an inelastic demand. These goods are
high priced goods and
only the richer section of society can afford these goods. Even with
a change in price,
demand does not change much for goods which are luxurious in nature.
Availability of substitutes
If substitutes are available in the market, demand for commodities
will be relatively elastic.
If substitutes are not available, demand will be inelastic in
nature.
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ATLANTIC INTERNATIONAL UNIVERSITY
Summer 2007 Phase � II
Price of product
If the price of a product is very low, demand is inelastic in
nature. A rise in price or a fall in
price is not going to change the demand for the product.
Position of the product in the consumer's budget
If the amount of money spent on the product is a small percentage of
the consumer's income,
the demand of the product will be inelastic in nature.
Postponement of demand
If the demand for a product can be postponed to a future date,
demand will be relatively
inelastic. If demand can be postponed, the people will be willing to
pay a higher price.
Therefore, the demand will be inelastic in nature.
Number of users
If the commodity can be used for a large number of purposes, its
demand will go up with a
fall in price. Therefore, the demand for the product will be elastic
in nature, on the other
hand single use goods will have an inelastic demand.
IMPORTANCE OF KNOWLEDGE OF ELASTICITY OF DEMAND
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ATLANTIC INTERNATIONAL UNIVERSITY
Summer 2007 Phase � II
Government decision making
Knowledge of elasticity is of great importance in framing important
policies of the
government like tax policies, trade policies, agricultural pricing
policy etc.
i.)
Tax policy
Government imposes various taxes for raising revenue. While imposing
taxes and fixing tax
rates, the knowledge of elasticity becomes very important. While
imposing taxes , the
government has to keep in mind the nature of elasticity of demand.
For goods which have an
elastic demand, high tax rates can not be fixed. Fixing the taxes or
increasing would imply a
rise in price of the product. If the demand for a product is
elastic, with rise in price, quantity
demanded will come down. For goods having inelastic demand, a rise
in tax will fetch more
revenue to the government.
ii.)
International trade policy
Knowledge of elasticity is of great importance in international
trade, if the goods exported
have an inelastic demand. Domestic country is at a favorable
position to as it can quote a
high price for its exports. If Imports have an elastic demand, it is
favorable for a domestic
country. The success of devaluation also depends on elasticity of
demand. Devaluation
refers to lowering value of domestic currency against a foreign
currency. Devaluation makes
Exports cheaper and imports costlier. However, it will be successful
only when exports are
elastic in nature and imports are also elastic in nature. Government
frames international
trade policies according to the elasticity of demand.
iii.)
Agricultural policies
Government fixes up the minimum price of agricultural products in
order to prevent a fall in
the price of the agricultural produce during a good harvest. When
the harvest is good and
productivity is high, there is a great supply of food grains in the
market. But the demand for
food grains and the agricultural products is inelastic in nature.
Therefore, prices of
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ATLANTIC INTERNATIONAL UNIVERSITY
Summer 2007 Phase � II
agricultural products fall because of excess of supply. This is a
loss to farming community.
Therefore, minimum support prices are fixed by the government to
prevent price of crops
from falling to a very low level.
In order to fix the price, knowledge of elasticity becomes very
important. Certain products
are necessities and yet there is a shortage of these products in the
market. To prevent rise in
price of such necessities the government fixes a price ceiling.
It helps government to identify certain services as public utility
services. Certain services
have an inelastic demand because it is a necessity and at the same
time there is a scarcity of
such services. In order to prevent growth of mono[poly and
exploitation of the consumer,
these services are taken over by the government and declared as
public utility and provided
to the public at a highly subsidized rate.
iv.)
Business decision-making
Pricing policy is an important part of the business decisions. The
prices that are fixed should
cover the cost of production and fetch profits for the producer. The
producer will always try
to maximize his profits. A higher price will fetch a higher profit
but it will not always be
possible for the producer to charge a higher price. In case of goods
having an elastic demand,
a rise in price will lead to a fall in quantity demanded bringing
down the profits of the
producer. So, the producer will not be successful in charging a high
price and making more
profits.
Knowledge of elasticity and trade unions
When the workers bargain for the higher wages, whether they will be
successful or not
depends on the nature of elasticity of the product which they help
to produce. Higher wages
will increase the cost of production. The cost of production is
reflected in the price of the
product. Thus the price of the product will rise. If the demand of
the product is elastic in
nature, the quantity demanded will fall with a rise in price. As a
result many workers will
loose their jobs. So for products having elastic demand, the workers
demand for higher
wages will not be successful.
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ATLANTIC INTERNATIONAL UNIVERSITY
Summer 2007 Phase � II
BIBLIOGRAPHY:
1.
An Introduction to Management Science: quantitative approaches to
decision making
� DR Anderson, DJ Sweeney, TA Williams � 2005
2.
Ecological Economics: the science and management of sustainability
� R Constanza �
1992
3.
The Measurement of Productive Efficiency: Techniques and
Applications � HO
Fried, CA Lovell, SS Schmidt � 1993
4.
Differential Games in Economics and Management Science � EJ
Dockner � 2000
5.
Forecasting and Management of Technology � AL Porter � 1991
6.
Numerical Methods in Economics � KL Judd � 1998
7.
The Economics of the Trade Union � AL Booth � 1995
8.
Application of Quantitative Techniques for the Prediction of Bank
Acquisition
Targets � F Pasiouras, C Zopounidis � 2005
9.
Strategic Business Forecasting: The Complete Guide to Forecasting
Real World
Company Performance � JK Shim - 2000
10. Accounting and Business Economics in Spain � VM Julve -
European Accounting
Review, 1998 - Taylor & Francis
11. Reverse Logistics: quantitative models for closed-loop supply
chains � R Dekker �
2004
12. Economic Transition, Strategy and the Evolution of Management
Accounting
Practices � SW Anderson, WN Lanen, International Motor Vehicle-
1996 -
imvp.mit.edu
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