managerial economics - ii

8/7/2019 Managerial Economics - II

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Managerial Economics II

Operational Issues

Demand


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Demand

Stonier and Hague - Demand ineconomics means demand backedup by enough money to pay for thegoods demanded

Benham - Demand for anything at agiven price is the amount of it,which will be bought per unit of

time at that Price

Demand has three essentials price,quantity demanded and time.


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LAW of Demand

Marshall the amountdemand increases with

a fall in price anddiminishes with a rise

in price


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Demand Schedule

Price of an Orange (In. Rs.) QuantityDemanded

10 1

8 2 6 3

4 4

2 5

The demand curve DD shows the inverserelation between price and quantitydemand ,It is downward sloping , which

can be seen from the chart.


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Demand Curve


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Assumptions - Demand

Law is demand is based on certainassumptions:

There is no change in consumers taste andpreferences.

Income should remain constant.

Prices of other goods should not change.

There should be no substitute for the

commodity The commodity should not confer at any

distinction

The demand for the commodity should be

continuous


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Exceptions to Law ofDemand

Giffen paradox The Giffen good or inferior good is an

exception to the law of demand FoodGrains

Demonstration effect

Rich people buy certain good because itgives social distinction or prestige forexample diamonds are bought by thericher class for the prestige it possess

Ignorance Sometimes, the quality of the commodity is

Judge by its price. Consumers think thatthe product is superior if the price is high.As such they buy more at a higher price


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Exceptions to Law ofDemand

Speculative effect If the price of the commodity is increasing the

consumers will buy more of it because of thefear that it increase still further, Thus, anincrease in price may not be accomplished by

a decrease in demand Fear of shortage

During the times of emergency of war Peoplemay expect shortage of a commodity. At thattime, they may buy more at a higher price to

keep stocks for the future Necessaries

In the case of necessaries like rice, vegetablesetc. people buy more even at a higher price


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Exceptional Demand Curve


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Factors affecting Demand

Price of the Commodity Income of the Consumer

Prices of related goods Substitutes (Teaand Coffee) Complementary ( Cup and

Saucer) Tastes of the Consumers

Wealth

Population

Government Policy Expectations regarding the future

Climate and weather

State of business Economy


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Demand Elasticity

Elasticity of demand explains therelationship between a change in priceand consequent change in amountdemanded

Marshall - Elasticity of demand shows theextent of change in quantity demanded toa change in price

Elastic demand: A small change in pricemay lead to a great change in quantitydemanded. In this case, demand is elastic.

In-elastic demand: If a big change in priceis followed by a small change in

demanded then the demand in inelastic


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Types of Elasticity ofDemand

There are three types of elasticity ofdemand:

Price elasticity of demand

Income elasticity of demand

Cross elasticity of demand


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Price Elasticity

Proportionate change in the quantity demand ofcommodity

Price Elasticity =

------------------------------------------ Proportionate change in the price of

commodity

Price elasticity of demand measureschanges in

quantity demand to a change in Price.

It is the


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Types of Elasticity

Perfectly elastic demand

When small change in price leads toan infinitely large change isquantity demand, it is calledperfectly or infinitely elasticdemand. In this case E=


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Perfectly elastic demand

curve


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Perfectly InelasticDemand

In this case, even a large change inprice fails to bring about a changein quantity demanded.

When price increases from OP toOP, the quantity demandedremains the same. In other words

the response of demand to achange in Price is nil. In this caseE=0.


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Perfectly InelasticDemand Curve


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Relatively elasticdemand

Demand changes more thanproportionately to a change inprice. i.e. a small change in price

loads to a very big change in thequantity demanded. In this case E> 1. This demand curve will be

flatter


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Relatively elasticdemand curve


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Relatively in-elasticdemand

Quantity demanded changes lessthan proportional to a change inprice. A large change in price leads

to small change in amountdemanded. Here E < 1. Demandedcarve will be steeper


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Relatively in-elasticdemand curve


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Unit elasticity of demand

The change in demand is exactlyequal to the change in price. Whenboth are equal E=1 and elasticity if

said to be unitary


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Unit elasticity of demandcurve


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Income elasticity ofdemand

Income elasticity of demand shows thechange in quantity demanded as a resultof a change in income. Income elasticityof demand may be slated in the form of a

formula. Proportionate change in the quantity demand

of commodity

Income Elasticity =-------------------------------------------------------

Proportionate change in theincome of the people

Income elasticity of demand can beclassified in to five types.


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Zero income elasticity

Quantity demanded remains thesame, even though money incomeincreases. Symbolically, it can be

expressed as Ey=0.


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Zero income elasticitycurve


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Negative Incomeelasticity

When income increases, quantitydemanded falls. In this case,income elasticity of demand is

negative. i.e., Ey < 0.


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Negative Incomeelasticity curve


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Unit income elasticity

When an increase in income bringsabout a proportionate increase inquantity demanded, and then

income elasticity of demand isequal to one. Ey = 1


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Unit income elasticitycurve


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Income elasticity greaterthan unity

In this case, an increase in comebrings about a more thanproportionate increase in quantity

demanded. Symbolically it can bewritten as Ey > 1.


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Income elasticity greater thanunity curve


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Income elasticity leasthan unity

When income increases quantitydemanded also increases but lessthan proportionately. In this case E

< 1


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Income elasticity leas thanunity curve


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Cross elasticity ofDemand

A change in the price of one commodityleads to a change in the quantitydemanded of another commodity. This iscalled a cross elasticity of demand. The

formula for cross elasticity of demand is:

Proportionate change in the quantity demandof commodity X

Cross elasticity=------------------------------------------------------

Proportionate change in the price ofcommodity Y


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In case of substitutes, crosselasticity of demand is positive. Eg:Coffee and Tea

When the price of coffee increases,Quantity demanded of tea

increases. Both are substitutes.

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C l i i f


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Incase of compliments, crosselasticity is negative. If increase inthe price of one commodity leads

to a decrease in the quantitydemanded of another and viceversa.

C l i i f


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C l ti it f


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In case of unrelatedcommodities, cross elasticity ofdemanded is zero. A change in the

price of one commodity will notaffect the quantity demanded ofanother

C l ti it f


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