Republic of the Philippines

SORSOGON STATE UNIVERSITY

Sorsogon Campus
Sorsogon City

LEARNING MODULE
MANAGERIAL ECONOMICS

Module 2: MARKET DEMAND

I. OVERVIEW
We are all consumers of goods and services. We all buy food and clothing which are necessary for our
survival as human beings. As students, you need to purchase books, calculators, pens, notebooks, papers, and in this
time of pandemic, laptops, tablets, internet load, etc. to help you in your studies. Perhaps, some of you would even
need a vacation from your daily routine; hence, you look for affordable travel packages. Given these premises, we
are all economic agents known as consumers. Looking at our own behavior as consumers, what is our reaction when
the price of a commodity is low? How about when it is high? What do you notice when your favorite mall declares a
3-day sale?

II. LEARNING OUTCOMES

After reading and studying this chapter, you will be able to:
• Define demand;
• Determine the factors affecting demand;
• Measure the elasticity of demand; and
• Realize the importance of demand analysis to business.

III. LEARNING EXPERIENCE

Demand
• In common parlance, it means desire for an object
• In economics, it means the desire backed up by purchasing power and willingness to buy • It refers to the
quantity of goods and services that people are ready to buy at given prices within a given time period.

Demand Analysis
An attempt to determine the factors affecting the demand of a commodity or service and to measure
such factors and their influences. The demand analysis includes the study of law of demand, demand schedule,
demand curve and demand forecasting.

Main Objectives of Demand Analysis:

• To determine the factors affecting demand.
• To measure the elasticity of demand.
• To forecast the demand.
• To increase the demand.
• To allocate the resources efficiently.

Law of Demand
• Shows the relationship between price and quantity demanded of a commodity in the market • According
to Alfred Marshall, “the amount demanded increases with a fall in price and diminishes with a rise in
price.”
• It simply states that while other things remain the same (ceteris paribus), an increase in price of a
commodity will decrease the demand for that commodity and a decrease in price will increase the
demand for the commodity.
• The relationship of price and demand is inverse or negative as they move in opposite direction.

The concept of the law of demand may be explained with the help of a demand schedule.

Demand Schedule - shows the various quantities the consumer is willing to buy at various prices.
Price of Apple Quantity Demanded

P35.00 1
 30.00 2

25.00 3

20.00 4

15.00 5

When the price falls from P35 to P30, the quantity demanded increases from one to two. As the price
falls further, quantity demanded increases. On the basis of the above demand schedule, we can illustrate the
demand curve as follows:

35 e

30 25
P

20

15

0
1 2 3 4 5 Qd

The downward slope of the demand curve indicates that as the price of apple increases, the demand for this
good decreases. The negative slope of the demand curve is due to income and substitution effects.

Income effect is felt when a change in price of a good changes consumer’s real income or purchasing power,
which is the capacity to buy with a given income. In other words, purchasing power is the volume of goods and
services one can buy with his/her income. If a good becomes more expensive, real income decreases and consumer
can only buy less goods and services with the same amount of money income. The opposite holds with a decrease
in the price of a good and increase in real income.

Substitution effect is felt when a change in price of a good changes demand due to alternative consumption
of substitute goods. For example, lower price encourages consumption away from higher-priced substitutes on top
of buying more with the budget (income effect). Conversely, higher price of a product encourages the consumption
of its cheaper substitutes further discouraging demand for the former which is already limited by less purchasing
power (income effect).

Non-Price Determinants of Demand

If the ceteris paribus assumption is dropped, non-price variables are now allowed to influence demand.
These non-price factors include income, taste, expectations, prices of related goods, and population. These non-
price determinants can cause an upward or downward change in the entire demand for the product and this
change is referred to as a shift of the demand curve.

• If consumer income decreases, the capacity to buy decreases and the demand will also decrease even when
price does remain the same. The opposite will happen when income increases.

• Improved taste for a product will cause a consumer to buy more of that good even if its price does not change.

• Another is consumer’s expectations of future price and income. Consumers tend to anticipate changes in the
price of a good. For example, when gasoline prices are expected to increase, motorists tend to fill-up their
gas tank before the price increase; the demand for oil will shift upward. But when a rollback is expected,
consumers will delay their purchases and wait for prices to decrease.

• Prices of related goods as substitutes or complements also determine demand.

a) Substitute goods are those that are used in place of each other, like butter and margarine, or sugar and
artificial sweeteners. In case of substitute goods, an increase in the demand of one good leads to the
decrease in demand for the other good. So, if the price of a good increases, the demand for that good
will decrease while the demand for its substitute will increase.
b) Complements are goods that are used together, such as cellphone and sim card, car and tires, coffee and
creamer. An increase in the demand for a good will increase the demand for the other good. Thus, if the
 price of a good increases, the demand for it will decrease and the demand for its complement will
likewise decrease.

• On the other hand, the number of consumers is also an important determinant that will affect market demand
for a good. The population makes up the group of consumers who will buy the product. The higher the
population, the more consumers and the higher the demand for the good.

Shift in Demand
When change in demand is caused by a non-price determinant, this will involve a change in the entire
demand curve. For example, the demand curve will shift to the right to reflect an increase in demand due to higher
income and to the left to show a decrease in demand due to less income.

Demand Function
• A functional relationship between demand and its various determinants expressed mathematically

a. Price Determinant
Qd = f (P)
This signifies that the quantity demanded for a good is dependent on the price of that good.

b. Non-Price Determinant
D = f (P, T, Y, E, PR, NC)
This states that demand for a good is a function of Price (P), Taste (T), Income (Y), Expectations (E ), Price of
Related Goods (PR), and Number of Consumers (NC).

Types of Demand
• Joint or Complementary Demand - when two or more goods are jointly demanded at the same time to
satisfy a particular want (demand for milk, sugar, coffee for making coffee)
• Composite Demand - the demand for commodity which can be used for several purposes (demand for
electricity)
• Direct Demand - demand for a commodity which is for direct consumption (food, clothing) • Derived
Demand - when the commodity is demanded as a result of the demand of another commodity (demand for
tires depends on demand for vehicles)
• Company Demand - demand for a product by a particular company
• Industry Demand - total demand for products of particular industry which includes several companies

Elasticity of Demand
• defined as “the degree of responsiveness in quantity demanded to a change in price”. Thus, it
represents the rate of change in quantity demanded due to a change in price.

Main types of elasticity of demand:

1. Price Elasticity of Demand.
2. Income Elasticity of Demand; and
3. Cross Elasticity of Demand.

Price Elasticity of demand

• measures the change in quantity demanded to a change in price. It is the ratio of percentage change in
quantity demanded to a percentage change in price. This can be measured by the following formula.
Price Elasticity = Proportionate change in quantity demanded
Proportionate change in price
 OR
Ep = Change in Quantity demanded / Quantity demanded
Change in Price/price
OR
Ep = (Q2-Q1)/Q1
(P2-P1) /P1

Where: Q1 = Quantity demanded before price change

Q2 = Quantity demanded after price change
P1 = Price charged before price change
P2 = Price charge after price change.

Degree of Price Elasticity of Demand:

1) Perfectly elastic demand (infinitely elastic)

When a small change in price leads to infinite change in quantity demanded, it is called perfectly elastic
demand. In this case the demand curve is a horizontal straight line as given below. (Here ep= ∞)

2) Perfectly inelastic demand

In this case, even a large change in price fails to bring about a change in quantity demanded. I.e. the
change in price will not affect the quantity demanded and quantity remains the same whatever the change in
price. Here demand curve will be vertical line as follows and ep= 0

2) Relatively elastic demand

Here a small change in price leads to very big change in quantity demanded. In this case demand curve
will be fatter one and ep=>1
 4) Relatively inelastic demand
Here quantity demanded changes less than proportionate to changes in price. A large change in price
leads to small change in demand. In this case demand curve will be steeper and

ep=<1

5) Unit elasticity of demand (unitary elastic)

Here the change in demand is exactly equal to the change in price. When both are equal, ep= 1, the
elasticity is said to be unitary.

The above five types of elasticity can be summarized as follows:

SL No type Numerical expression 1 One Rectangular hyperbola

description Shape of curve
1 Perfectly elastic
2 Perfectly inelastic
3 Unitary elastic
α infinity Horizontal 0 Zero Vertical
4 Relatively elastic >1 More than one Flat

5 Relatively inelastic Income Elasticity of Demand

<1 Less than one Steep

• shows the change in quantity demanded as a result of a change in consumers‟ income. Income
 elasticity of demand may be stated in the form of formula:
Ey = Proportionate Change in Quantity Demanded
Proportionate Change in Income

Three Main Types:

1) Zero income Elasticity.
2) Negative income Elasticity
3) Positive income Elasticity.

Zero income elasticity – In this case, quantity demanded remain the same, eventhough money income
increases.ie, changes in the income doesn’t influence the quantity demanded (Eg. salt, sugar, etc). Here,
Ey (income elasticity) = 0

Negative income elasticity -In this case, when income increases, quantity demanded falls.Eg, inferior goods.
Here, Ey = < 0.

Positive income Elasticity - In this case, an increase in income may lead to an increase in the quantity
demanded. i.e., when income rises, demand also rises. (Ey =>0)
Further classified into three:
a) Unit income elasticity; Demand changes in same proportion to change in income.i.e, Ey = 1 b)
Income elasticity greater than unity: An increase in income brings about a more than proportionate
increase in quantity demanded.,i.e, Ey =>1
c) Income elasticity less than unity: when income increases quantity demanded is also increases but
less than proportionately. i.e., Ey = <1

Business decisions based on income elasticity:

• If income elasticity is greater than Zero, but less than one, sales of the product will increase but slower
than the general economic growth
• If income elasticity is greater than one, sales of his product will increase more rapidly than the general
economic growth.
• Firms whose demand functions have high income elasticity have good growth opportunities in an
expanding economy. This concept helps manager to take correct decision during business cycle and
also helps in forecasting the effect of changes in income on demand.

Cross Elasticity of Demand

is the proportionate change in the quantity demanded of a commodity in response to change in the
price of another related commodity. Related commodity may either substitutes or complements. Examples of
substitute commodities are tea and coffee. Examples of compliment commodities are car and petrol. Cross
elasticity of demand can be calculated by the following formula:

Cross Elasticity = Proportionate Change in Quantity Demanded of a Commodity

Proportionate Change in the Price of Related Commodity

If the cross elasticity is positive, the commodities are said to be substitutes and if cross elasticity is
negative, the commodities are compliments. The substitute goods (tea and Coffee) have positive cross
elasticity because the increase in the price of tea may increase the demand of the coffee and the consumer
may shift from the consumption of tea to coffee.

Complementary goods (car and petrol) have negative cross elasticity because increase in the price of
car will reduce the quantity demanded of petrol.

The concept of cross elasticity assists the manager in the process of decision making. For fixing the
price of product which having close substitutes or compliments, cross elasticity is very useful.

Advertisement Elasticity of Demand

• (Promotional elasticity of demand) measure the responsiveness of demand due to a change in
advertisement and other promotional expenses. This can be measured by the following formula;

Advertisement Elasticity = Proportionate Increase in Sales

Proportionate increase in Advertisement expenditure.
Determinants of advertisement elasticity:
 • Type of commodity- elasticity will be higher for luxury, new product, growing product etc., •
Market share – larger the market share of the firm lower will be promotional elasticity. • Rival’s
reaction – if the rivals react to increase in firm’s advertisement by increasing their own
advertisement expenditure, it will reduce the advertisement elasticity of the firm.
• State of economy – if economic conditions are good, the consumers are more likely to respond to the
advertisement of the firm.

Advertisement elasticity helps in the process of decision making. It helps to deciding the optimum level
of advertisement and promotional cost. If the advertisement elasticity is high, it is profitable to spend more on
advertisement. Hence, advertisement elasticity helps to decide optimum advertisement and promotional
outlay.

Importance of Elasticity:
1. Production- Producers generally decide their production level on the basis of demand for their product.
Hence elasticity of demand helps to fix the level of output.
2. Price fixation- Each seller under monopoly and imperfect competition has to take into account the elasticity
of demand while fixing their price. If the demand for the product is inelastic, he can fix a higher price. 3.
Distribution- Elasticity helps in the determination of rewards for factors of production. For example, if the
demand for labor is inelastic, trade union can raise wages.
4. International trade- This concept helps in finding out the terms of trade between two countries. Terms of
trade means rate at which domestic commodities is exchanged for foreign commodities. 5. Public finance-
This assists the government in formulating tax policies. In order to impose tax on a commodity, the
government should take into consideration the demand elasticity.
6. Nationalization- Elasticity of demand helps the government to decide about nationalization of industries.
7. Price discrimination- A manufacture can fix a higher price for the product which have inelastic demand and
lower price for product which have elastic demand.
8. Others- The concept elasticity of demand also helping in taking other vital decision E.g.: Determining the
price of joint product, take over decision etc.

Determinants of Elasticity

Elasticity of demand varies from product to product, time to time and market to market. This is due to
influence of various factors:
• Nature of commodity- Demand for necessary goods (salt, rice,etc,) is inelastic. Demand for comfort and
luxury good are elastic.
• Availability/range of substitutes – A commodity against which lot of substitutes are available, the
demand for that is elastic. But the goods which have no substitutes, demand is inelastic. • Extent
/variety of uses- a commodity having a variety of uses has a comparatively elastic demand. E.g. demand
for steel, electricity etc..
• Postponement/urgency of demand- if the consumption of a commodity can be post pond, then it will
have elastic demand. Urgent commodity has inelastic demand.
• Income level- income level also influences the elasticity.
• Amount of money spend on the commodity- where an individual spends only a small portion of his
income on the commodity, the price change doesn’t materially affect the demand for the commodity,
and the demand is inelastic... (match box, salt, etc.)
• Durability of commodity- if the commodity is durable or repairable at a substantially less amount (eg.,
shoes), the demand for that is elastic.
• Purchase frequency of a product/time –if the frequency of purchase of a product is very high, the
demand is likely to be more price elastic.
• Range of Prices- if the products at very high price or at very low price having inelastic demand since a
slight change in price will not affect the quantity demand.

V. ASSESSMENT ACTIVITIES: (Posted in Google Classroom)

Prepared by:

MARIA LUISA P. MIRASOL

Assistant Professor II
[email protected]