6 ee eeceee DEMAND 1 Philippine economic growth had been demand ~ or consumer—driven. Exasperated by the high market prices then prevailing, President Ramon Magsaysay was said to have ordered that the law of supply and demand be repealed, However ludicrous this may so the analysis of demand and s analysis. In this chapter, und, it only points out the fact that upply is fundamental in economic we study the concept of demand, the law of demand which relates prices to quantity demanded, income and substitution effects, the factors affecting demand and how a change in these factors translates into shifts of the demand curve. We also look into the concept of elasticity which relates the sensitivity of consumers in responding to price and other changes. Lastly, we will also briefly look into the concept of utility and the idea that the consumer’s demand curve is a result of the consumer choosing the In the past it was reported tha Tue Concert or DEMAND Very simply put, demand refers to the amount of a good or service that a consumer is both willing and able to Purchase during a specified period of time. For example, Bert might be willing to purchase a pair of shorts for 200 pesos a pair Per quarter or two Pairs per quarter if the price fell to 150 Pesos. The observed law of demand Says that quantity demanded rises as Price falls, ceteris paribus, which Means holding everything else Constant. Alternatively, when prices rise, quantity demanded falls, again 4ssuming all other things remain bundle of commodities which maximizes his utility. unchanged. In other words, demand and prices are inversely or negatively related to each other. The ceteris paribus assumption is important since there are other factors that affect the demand for a specific commodity or service. For example, quantity demanded of Brand J hamburgers will not only depend on its price but also on the prices of Brand M and Brand W hamburgers. Thus, if the relative price of Brand J increases, fewer Brand J hamburgers will be bought. The demand-price relationship can be depicted in three different ways: via Demand + 51a schedule or table, a graph, or an equation. A demand schedule or table is a numerical listing of the quantity demanded of a commodity and/or service at alternative prices, assuming other things are held fixed. From Table 6.1, we see that the weekly demand for squid balls is 5 sticks if the price is 6 pesos but quantity demanded falls to a single stick if price goes up to PhP 14. Table 6.1 Demand schedule for squid balls The third way to illustrate the dem: and demanded (Q,) is expressed as a math thus, be expressed as: A demand curve illustrates the same information contained in «), demand schedule. The demand cur, is a geometric representation of 1),, reaction of consumer demand to various prices of the commodity 9, service being studied. We have pric, on the vertical axis and quantity demanded on the horizontal axis. Each point in the demand curve then represents a quantity-price com. bination. Thus, at point A in Figure 6.1 2 sticks of squid balls will be demanded at 12 pesos per stick while at point B, 6 sticks will be demanded at 4 pesos per stick. Connecting all the possible combinations, we have what is called the demand curve, The demand curve is downward sloping, illustrating the negative or inverse relationship between prices and quantity demanded.' Price relationship is through a demand functi as t ion. Quantity ‘ematical function of price (P). The demand function may, tercey Price is zero and the term (-b) is the slope cf the teeta OF the quantity demanded when for our earlier example is 52 + UNIT2: Economic Analysis - A Microeconomic ApproachA change in the quantity demanded for any commodity arises solely from price changes. Thus, the movement from point A to point B which resulted ina change in quantity demanded from 2 sticks to 6 sticks was triggered by a fall in price. This movement is a result basically of two effects: an income effect and a substitution effect. A fall in price essentially translates into an increase in the purchasing power of the consumer which allows the consumer to purchase more of the item. This is the income effect. For instance, if the price of a ballpen is PhP10, and the consumer has PhP50 to spend, he can purchase 5 ballpens. A fall in the price to PhPS will allow the consumer to buy 10 ballpens, even though his income was unchanged. In other words, the purchasing power of the consumer has increased. The substitution effect, on the other hand, suggests that when prices of a commodity or service falls, the consumer has an incentive to switch to the relatively cheaper good. A decline in the price of chicken will encourage housewives to substitute chicken for beef or fish. Similarly, students will switch to siopao if the price of siomai increases. The income and substitution effects combine and allow the consumers to purchase more of a product at a low price than at a high price (McConnell and Brue, 1996). Factors AFFECTING DEMAND The previous section looked at the relationship between the price and quantity demanded of a product. In making the assertion that quantity demanded falls as price increases, we held other relevant factors constant. Aside from price, the following are the other factors which may influence demand: (a) income; (b) prices of related goods in consumption; (c) consumer tastes and preferences; (d) consumer expectations; and (e) number of consumers, Income A higher income means that the consumer has a greater ability to buy goods or services. Hence, a higher income generally indicates a higher demand for most products. In this case, when the consumer’s income increases and nothing else changes, the entire demand curve shifts to the right. Given the same price, denfand for the commodity has increased. On the other hand, when income falls, demand is reduced and the entire demand curve shifts to the left. Goods are said to be normal goods when demand for these ‘goods increases as income increases or demand decreases when income falls. Inferior goods, however, are goods for which the demand falls when income * increases. Hamburgers are usually cited as an example of an inferior good because demand for hamburger and other types of patties declines when the consumer has more income. With a higher income, the consumer is able to purchase high-grade meat cuts. Used clothes may also be considered to be inferior goods. Prices of related goods in consumption Goods may either be substitutes or complements for each other. Substitute goods perform the same function; pencils and ballpens are both writing tools. When the price of ballpens increases, the demand for pencils increases, causing the demand curve for pencils to shift to the right. Again, at the same price, the demand Demand + 53for the pencils has increased. On the other hand, when the price of ballpens declines, the demand for pencils decreases, shifting the demand curve for pencils to the left. Complements or complementary goods are always consumed together. Whiteboard markers and whiteboards are examples of complements. The demand for whiteboards would fall if prices of board markers were to increase. The demand for the related good increases when the price ofa complementary good falls; and the demand curve for the related good shifts to the right. A CD player and a CD are also complementary goods. Consumer tastes and preferences When consumer tastes and preferences shift towards a particular good, greater amounts of the product are demanded at every possible price and the demand curve for the commodity shifts to the right. The demand for red roses increases come February 14 while the demand for white frocks increases at graduation time. The demand curve shifts to the left if consumer preferences shift in the opposite direction and the good becomes less wanted than before. Consumer expectations The current demand for a y, variety of goods or services is atte by consumer expectations about futur, prices and income. Demand for dried fy), could increase as the rainy and typhoo, season approaches. Similarly, th. demand for a specitie model of compute, falls if'consumers expect a new compute, model to be introduced to the market soon. ide ted Number of consumers The market demand for a commodity is affected by the number of consumers The market demand for a commodity is the summation of the individual demand schedules. Therefore, when the number of consumers increases, the market demand curve shifts to the right. An increase in population inevitably results in the increase in demand for mass transportation and mass housing. Figure 6.2 illustrates the right and leftward shifts of the demand curve. The demand curve D shifts to D, , for instance, when income increases and the good is a normal good while the curve shifts to the left or to D, when income falls. At point A on the demand curve D, price is P, and quantity demanded is Q,. At the same price but with an increase in Quantity Q a Figure 6.2 Shifts of the demand curve 54 + UNIT2: Economic Analysis - A Microeconomic Approachincome, we have point B on demand curve D, where quantity demanded of the commodity is now Q,. A reduction in income results in lower demand for the commodity, represented by point C on the demand curve D,. To summarize, when any of the above-mentioned factors changes, the entire demand curve shifts either to the right (demand has increased) or to the eft (demand has decreased). We use the terms “demand has increased” or «demand has decreased” as the case may be, to describe the shift of the curve. This is to be contrasted with a movement along the demand curve which is due solely to a change in price levels. When the price of a good or service increases, we say that there has been a decrease in quantity demanded of the good; when price falls, we note an increase in quantity demanded. In either case, what we observe is just a movement along the demand curve (Recall Figure 6.1). Own PRICE ELASTICITY OF DEMAND The own price elasticity of demand is a measure of how responsive is the quantity demanded of a particular good following a change in its own price. Elasticity is a relative concept; it compares percentage changes in quantity demanded to percentage changes in price. For example, how much less will consumers buy of imitation CDs when its price increases? Or to be more specific, if prices increase by 10 percent, will consumers reduce their demand by the same 10 percent, by less than 10 percent or by more than 10 percent? Own price elasticity of demand is defined as the ratio of the percentage change in quantity demanded to the percentage change in price, or _%A in O, (6.2) %A in P Therefore given two points on the demand curve, own price elasticity of demand is given by Qa, — Qa, Qd, + Qd, P,=P, Pi+P, (6.3) where the subscripts 1 and 2 refer to the two price and quantity combi- nations chosen. Figure 6.3 illustrates Figure 6.3 Own price elasticity of demand Demand + 55the elasticity concept. Ifa sago vendor finds that quantity demanded is 2 glasses when the price is 4 pesos at point 2 and quantity demanded drops to | glass when price rises to 5 pesos at point 1, the own price elasticity of demand is 2-1 4-5 ital 64 An own price elasticity of demand value of 3 means that the response of quantity demanded is thrice the size of the change in price in percentage terms. The negative sign highlights the inverse relationship between Price and quantity demanded. Our Sago vendor can expect the amount of sago he sells to fall by 30 percent if he increases Price by 10 percent or to increase by 15 percent if he lowers price by 5 percent, If we take their absolute values, ie. disregard the negative sign, clasticity values can range from zero to infinity. When the resulting Percentage change in quantity demanded is greater than the Percentage change in price, € is greater than 1, and demand is considered to be price elastic or demand is relatively sensitive to small Price changes, In this case, it would not be wise for the businessman who Figure 6.4 The perfectly inelastic demand curve’ 56 + UNIT 2: Economic Analysis SASS ie ed aspires for greater sales to j Prices, because the quantity dey of his product will fall by an even larger percentage. The Previous numerical example is a case in poiny (Figure 6.3), If the percentage change in quantity demanded is less than the Percentage change in price, &1 is lex than 1, and demand is said to be Price inelastic. Quantity demanded is relatively insensitive to small price changes. The astute businessman can take advantage of this by raising prices since the percentage fall in quantity demanded is less than the Percentage change in price. In the case where the percentage change in quantity demanded is equal to the percentage change in price, demand is said to be unit elastic or &4 is equal to 1. Here, it makes no sense for the businessman to alter his price if his goal is to increase sales because the percentage change in price will be matched by an equal percentage change in quantity demanded (but in the opposite direction), When quantity demanded does not change as price chan, ges, £4 is equal to 0, and demand is said to be perfectly inelasti This is depicted by a vertical demand curve, where quantity demanded Stays at a certain amount no matter what the price is (Figure 6.4). Ncrease Manded Quantity haha A Microeconomic Approach0 Figure 6.5 The perfectly elastic demand curve A heart patient who needs to take medication daily has a perfectly inelastic demand for the heart medicine. Demand is perfectly elastic, or &« is equal to ©, when consumers are prepared to buy all they can of the product at some price and none at all at any other price. In this case, the demand curve is horizontal (Figure 6.5). DETERMINANTS OF OWN PRICE Exasticity oF DEMAND There are several factors which may influence the value of own price elasticity of demand. Demand will be more elastic when excellent substitutes for the product exist, The presence of excellent substitutes allows the consumer to switch to these other goods more easily. Similarly, the greater the number of uses for the £00d, the more elastic the demand will be. This is so because the wider the Tange of uses for the product, the Breater the possibility for variation in quantity demanded as its price is altered. Demand for goods that take a large chunk of the consumer’s budget is likely to be more elastic. Thus, a high school student’s demand for a pair of denim pants is more elastic than his Quantity demand for ballpen. Demand also tends to be more price elastic, the longer the time period being studied. Since most consumers are creatures of habit, it takes time to experiment with other products when the price of another item changes. It takes time for consumers “to develop a taste” for most goods or services (Costales, et al., 2000). Tue Concept oF UTILITY The consumption of any good or service is assumed to give the consumer satisfaction or utility. If we assume that the consumer is able to explicitly assign to every good or a bundle of goods a number to represent the amount of utility or utils, then we are referring to what is called cardinal utility. For example, two pieces of fish balls give the consumer 10 utils while the same amount of squid balls only give the consumer 5 utils. The cardinal utility theory tells us therefore, that the consumer would prefer fish balls to squid balls since the former gives him twice as many utils of satisfaction. The assumption that every consumer is able to assign a numerical value representing the amount of utils that consumption of a good gives him Demand + 57is quite untenable. It would be more realistic to say that consumers can rank bundles of commodities according to their order of preference. This is known ‘as the ordinal utility approach. Using the previous example, we can say that the consumer prefers fish balls over squid balls since he derives ahigher level ‘of satisfaction from eating the former. The overall level of satisfaction or utility derived from consuming a good or service is known as total utility. For example, drinking one glass of iced tea gives a utility of 15. A second glass adds 10 utils for a total of 25 utils of total satisfaction. The total utility from drinking two glasses of iced tea is 25 while the marginal utility from the second glass is 10 utils. Marginal utility is the additional satisfaction arising from the consumption of an extra unit of a good and/or service. It is the change in total utility per unit change in the good and/or servic. consumed. A salient point in economics is {h, notion of diminishing margingy utility. As a consumer increases hi, consumption of a good and/or service, the marginal utility obtained from each additional unit of the good and/or service will at some point decrease The principle of diminishing marginal utility explains why the demand curve is generally downward sloping Additional units of a good contribute less and less to total utility ang therefore, you would not be willing to pay the same price for each unit of good consumed. In fact, you would be willing to pay a lower price for the additional unit. Thus, we end up with a demand curve that has an inverse relationship with price. SumMary of value. One of the fundamental components of a market for any commodity is the demand component. The demand side re consumers, their purchasing power, presents the preferences of and their willingness to pay for a thing Demand refers to the amount of a good or service that consumers are both willing and able to purchase for a specified period of time. The law of demand states that quantity demanded of. Roe ia 7 ; a good ora servi own price. ice is inversely related to itsWhen the demand curve shifts to the Ifthe demand curve shifts to the left, demand, The own price elasticity of demand is measure of how responsive is the quantity demanded of a particular good following a change in its own price The demand for any good and/or service may be price elastic, price inelastic, unit clastic, perfectly clastic or perfectly inelastic. : The consumption of any good or service is assumed to give the consumer satisfaction or utility. Utility may be measured by the cardinal or ordinal approaches. According to the diminishing marginal utility principle, as a consumer increases his consumption of a good and/or service, the marginal utility obtained from each additional unit of the good and/or service decreases. right, we say that demand has increased. we say that there has been a decrease in Key Concerts demand law of demand movement along the demand income effect curve . substitution effect normal good inferior good substitute complement own price elasticity of demand _perfectly inelastic perfectly elastic utility cardinal utility ordinal utility marginal utility diminishing marginal utility shift of the demand curve price elastic price inelastic unit elastic Demand + 59