managerial economic ch2

8/10/2019 Managerial Economic CH2

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Chapter 2: Demand

Chapter 2

Demand

LEARNING OBJECTIVES

Appreciate why consumers and business buyers buy more at lowerprices.

Distinguish consumer demand for normal products and inferiorproducts.

Appreciate the impact on demand of changes in the prices ofsubstitutes and complements.

Understand dierences between consumer and business demand.

Appreciate the concept of buyer surplus. Apply package deals and two-part pricing to extract buyer surplus.

KEY TAKEAWAYS

Owing to diminishing marginal benet! consumers and businessbuyers buy more at lower prices.

"onsumer demand for normal products increases with income! while

consumer demand for inferior products decreases with income. #he demand for a product increases with the price of a substitute! and

decreases with the price of a complement. $usiness demand increases with the output of the item being

produced. $uyer surplus is the dierence between the buyers% total benet from

consumption and the buyers% actual expenditure.

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Chapter 2: Demand

A seller can extract the buyers% surplus and raise prot by sellingthrough package deals and two-part pricing.

DETAILED NOTES

A The Demand Curve. A demand cur,e describes the /uantity demandedof an item as a function of its price.

$ Indvdua! Demand.' "onstruction.

i0 Denition1 A graph showing the /uantity hori3ontal axis! e.g.! no.of mo,ies watched per month0 that the buyer will purchase ate,ery possible price ,ertical axis! e.g.! ticket price per mo,ie0.

2 4lope.i0 "ar#na! $ene%t5 the benet pro,ided by an additional unit of

the item.ii0 #heprinciple of diminishing marginal benet- each additional unit

of consumption pro,ides less benet than the proceeding unit.Accordingly! the price that an indi,idual is willing to pay willdecrease with the /uantity purchased.

iii0 Diminishing marginal benet gi,es rise to a downward slopingdemand cur,e1 the lower the price! the larger the /uantitydemanded.

6 references.i0 #he procedure for constructing a demand cur,e relies completely

on the consumer%s indi,idual preferences and this has two

implications1'0Dierent consumers may ha,e dierent preferences and hence

dierent demand cur,es720Demand cur,es will change with changes in the consumer%s

preferences.

" Demand and In&'me.' In&'me &han#e(.

i0 A change in income will aect indi,idual demand at all price le,els.ii0 A change in price ,is a ,is changes in income or other factors on

indi,idual demand.

'0A change in the price of an item holding income and all otherfactors unchanged0 generally causes mo,ement alongthedemand cur,e a change in the /uantity demanded0

20A change in income or factors other than the price of an iteme.g.! the prices of related products! ad,ertising! season!weather! and location0 causes a shiftin the entire demandcur,e a change in demand at all price le,els0.

2 8ormal ,is 9 ,isinferior products.

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Chapter 2: Demandi0 :oods and ser,ices are categori3ed according to the eect of

changes in income on demand.ii0 N'rma! pr'du&t)demand is positi,ely related to the buyer;s

income. Demand increases as buyer;s income increases! and

demand falls as buyer;s income falls.'0


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Chapter 2: Demandiii0 #he eect of ad,ertising expenditure on demand may be sub=ect to

diminishing marginal product - each additional dollar spent onad,ertising has a relati,ely smaller eect on demand.

> Bu(ne(( Demand.' Input(.i0 "onsumers buy goods and ser,ices for nal consumption or usage.ii0 $usinesses buy goods and ser,ices as inputs for the production of

other goods and ser,ices for sale to consumers or other businesses.iii0 #he inputs purchased by a business can be classied into materials!

energy! labor! and capital.i,0 #he inputs may be substitutes workers?machines0 or complements

trucks and dri,ers0.2 Demand.

i0 $y increasing inputs! the business can produce a larger output and

raise re,enue.ii0 Demand cur,e of a business.'0A business can measure its marginal benet from an input as the

increase in re,enue arising from an additional unit of the input.20"onstruct the demand cur,e of a business for an input using the

marginal benet of an input.60A business should buy an input up to the /uantity that its

marginal benet from the input exactly balances the price.@0+f the input pro,ides a diminishing marginal benetto the

business! the demand cur,e for the input slopes downward.6 Demand *a&t'r(.

i0 A change in the price of an input is represented by a mo,ementalongthe demand cur,e.ii0 "hanges in other factors will lead to a shiftof the entire demand

cur,e.'0A ma=or factor in consumer demand is income. $usiness

demand does not depend on income but rather on the 'utput5if the output is larger! the demand for inputs will increase.

20#he demand for an input also depends on the pr&e( '*&'mp!ement( and (u$(ttute(in the production of the output.>.g.! trucks and dri,ers are complements 5 an increase indri,ers; wages will reduce the demand for trucks.

Bu-er Surp!u(.' +mplication for pricing policy1 the perspecti,e of Bwillingness to payC

shows the maximum that the buyer can be charged.2 #he indi,idual demand cur,e shows1

i0 #he /uantity that the buyer will purchase at e,ery possible price7and

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Chapter 2: Demandii0 #he maximum amount that a buyer is wiling to pay for each unitof

the item! i.e.! the buyer;s mar#na! $ene%tfrom each unit.6 T'ta! $ene%t.

i0 #otal benet1 the benet pro,ided by all the units that the buyer

consumes! i.e.! the marginal benets from the rst up to andincluding the last unit purchased.ii0 :raphically! this is the area under the buyer%s demand cur,e up to

an including the last unit consumed.iii0 #his is the maximum that the buyer is willing to pay for that

/uantity of purchases! this is also the mamumthat a (e!!er &an&har#e.

@ $enet and expenditure.i0 Bu-er (urp!u(1 #he dierence between the buyer%s total benet

from some consumption and her or his actual expenditure.ii0 :raphically represented by the area between the buyer;s demand

cur,e and the price line.iii0 >ect of price changes. rice reduction leads to increase in buyer;ssurplus in two ways.'0irst! the buyer gets a lower price on the /uantity that the buyer

would ha,e purchased at the original higher price7 and204econd! as the buyer buys more depending on the buyer;s

sensiti,ity to the price reduction0! she gains buyer surplus oneach of the additional purchases.

i,0 #he buyer loses from a price increase.'0 ay higher price7 and20 eduction in the /uantity purchased.

E ,a&/a#e dea!( and t0' part pr&n#. A seller who has completeFexibility o,er pricing maximi3es prot by charging buyer =ust a littleless than total benet 5 extractingbuyer;s surplus as follows1i0 ackage deal1 A pricing scheme comprising a xed payment for a

xed /uantity of consumption.ii0 #wo-part price1 a pricing scheme comprising a xed payment and a

charge based on usage! e.g.! telephone monthly charge coupledwith an airtime charge.

iii0 A combination of the abo,e two pricing techni/ues.

: "ar/et Demand.

' "onstruction of market demand cur,e.i0 Denition1 A graph showing the /uantity that all buyers willpurchase at e,ery possible price. +t is the hori3ontal summation ofthe indi,idual demand cur,es.

ii0 +t enables businesses to understand the demand of the entiremarket rather than indi,idual customers.

2 #he properties of the market demand cur,e are similar to those of theindi,idual demand cur,e.

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Chapter 2: Demand6 4lope. As each buyer;s marginal benet diminisheswith the /uantity

of consumption! the market demand cur,e slopes downward. At alower price! the market as a whole will buy a larger /uantity.

@ rice changes! income changes and other factors in demand.

i0 A change in the price of an item holding income and all otherfactors unchanged0 generally causes movementalong the marketdemand cur,e from one point to another on the same cur,e.

ii0 A change in income or factors other than the price of an item e.g.!the prices of related products! ad,ertising0 causes a shiftof theentire market demand cur,e.

E Garket demand for a business input depends on output of allbusinesses and the prices of related products.

H "ar/et $u-er (urp!u(.i0 #his is the dierence between the buyers; total benet from the

input and the buyers; actual expenditure.

ii0 :raphically! it is the area between the market demand cur,e andthe price line.

,ROGRESS C1ECKS AND REVIEW 23ESTIONS

lease refer to the textbook for answers to selected rogress "heck ande,iew /uestions.

DISC3SSION 23ESTION 45 AND ANSWER

An important issue in economic de,elopment is the relationship betweenfertility and female literacy.


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Chapter 2: Demandc0 +n the chart! mark Bcost of childC on the ,ertical axis. Does the trend

line ha,e any relation to a demand cur,eK lease explain.d0lease gi,e an alternati,e explanation of the gure1 Use the fertility

rate to explain female literacy.

Answera0ertility rate L @.E.b0Migher the opportunity cost is higher0.c0 #he trend line is like a demand cur,e1 the lower is the cost of a child!

the higher is the fertility rate.d0

managerial economic ch2

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