Understanding Consumer Demand

Understanding Consumer Demand

Basics of Consumer Demand Scarcity Price allocates scare resources Two principles of consumer behavior Consumers always select the item that gives highest level satisfaction (utility maximization) Additional satisfaction from consumption of each additional unit declines (diminishing marginal utility)

Factors Influencing Consumer Demand What does demand mean? What does the law of demand mean?

Factors Influencing Consumer Demand Seven factors affecting the demand Price of product Price of competitor’s products (substitute products) Price of complement goods Income Population Taste and preferences Seasonality

Demand Shifters Q2 Price Price 1 2 3 4 5 Quantity 1 50 40 30 20 10 Quantity 2 60 50 40 30 20 5 Q1 4 3 Demand shifters Population Consumer taste and preference Income Price of substitutes Price of complements, etc 2 1 10 20 30 40 50 Quantity

Demand Elasticity What is Elasticity? Classifying sales response Elastic Inelastic Unitary

Price Elasticity Ep % change in quantity % change in price

Price Elasticity Example: Price of caviar increases from 20 to 25 per pound and quantity demand declines from 100 pounds to 50 pounds, What is the price elasticity of caviar? Ep % change in quantity of caviar % change in price of caviar -50% 25% What this tells a business manager? -2

Cross-Price Elasticity Ecp % change in quantity % change in price of a competitor’s or complementary product

Cross-Price Elasticity Example: Price of cracker increase from 0.50 to 1.00 per pound and caviar sales decrease from 100 pounds to 80 pounds, What is cross- price elasticity of caviar to crackers? Ecp % change in quantity of caviar % change in price of crackers -20% 100% What this tells a business manager? -0.2

Income Elasticity Ey % change in quantity % change in income

Income Elasticity Example: Consumers increase from 30,000 to 33,000 and Caviar sales increased from 100 pounds to 120 pounds, What is the income elasticity of caviar? Ey % change in sales of caviar % change in income 20% 10% What this tell a business manager? 2

Relationship Between Price, Total Revenue, and Elasticity Ep Elasticity Effect on total revenue 1 Inelastic Price rise total revenue up Price decline total revenue down 1 Unitary Price rise total revenue unchanged Price decline total revenue unchanged 1 Elastic Price rise total revenue down Price decline total revenue up

Why Demand for a Single Food is Elastic Price E D C B A 0 Sales (Quantity demanded) A: all food items B: all dairy product C: all ice cream D: all vanilla ice cream E: Haagen-Dazs vanilla ice cream