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Module 2-(AEC 112) Theory of Demand

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18 views

Module 2-(AEC 112) Theory of Demand

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RodolfoFaldas
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© © All Rights Reserved
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A MODULE IN MANAGERIAL ECONOMICS

MODULE 2
THEORY OF DEMAND

LEARNING OUTCOMES
At the end of the session, students are expected to:

1) appreciate the significance of demand analysis;


2) understand the concepts of demand and types of demand;
3) know the factors influencing the demand for a product;
4) distinguish between the changes in quantity demanded and changes in demand; and
5) understand the demand schedule, demand curve and the law of demand.

INTRODUCTION
The purpose of the theory of demand is to determine the various factors that affect demand. One
often reads that the theory of demand is the establishment of the 'law of demand' (that the market demand
is negatively related to the price) but this is misleading in that it concentrates on price as the sole
determinant of demand, ceteris paribus. Demand is a multivariate relationship, that is, it is determined by
many factors simultaneously. Some of the most important determinants of the market demand for a
particular product are its own price, consumers' income, prices of other commodities, consumers' tastes,
income distribution, total population, consumers' wealth, credit availability, government policy, past
levels of demand, and past levels of income. The traditional theory of demand has concentrated on four of
the above determinants, the price of the commodity, other prices, income and tastes. Some of the other
factors have been introduced in the theory of demand recently. We will first examine the traditional static
theory of demand and subsequently we will briefly discuss some recent developments in this field. It
should be noted that the traditional theory of demand examines only the final consumers' demand for
durables and non-durables. It is partial in its approach in that it examines the demand in one market in
isolation from the conditions of demand in other markets. An important implicit assumption of the theory
of demand is that firms sell their products directly to the final consumers. This is not the general case in
the modern business world and this has serious implications for the determination of prices. Another
shortcoming of the traditional theory is that it does not deal with the demand for investment goods, nor
with the demand for intermediate products. Total demand includes final demand and intermediate
demand. Final demand is subdivided into consumers' demand and demand for investment goods.
Traditional theory of demand deals only with consumers' demand, which is only a fraction 1 of the total
demand in the economy as a whole.
ACTIVITY
 Reflection Paper. Read and reflect on the case Oil for the World. Answer the questions at the end of
the article.

Case
Some hate it and some love it, but regardless of how you feel oil is still a key part of our daily lives. The
average Canadian uses about 20 barrels of oil each year, equivalent to about one and a half swimming
pools. Since it is such a major part of our expenses, oil is a product where, when price changes, we really
notice. In 2008, China’s expansion sparked a long period of high prices. In this case study, we will
analyze what has happened to these prices over time and the impact this has had on oil producers from the
lens of producer theory. To simplify our case study, let’s assume that the oil market is perfect
competition.
The period of high prices indeed incentivized private firms to search farther than ever before – in the
Arctic, Brazil’s pre-salt fields, deep waters off Angola, and Canada’s oil sands to ever expand the supply
of oil. Investors encouraged this activity, rewarding future growth as much as profitability.
Oil prices have been quite volatile. Recently, from mid 2014 to early 2016 oil prices plummeted from
$110 a barrel to around $27. This sharp decline has been due to a number of causes. A key cause was
when sanctions were lifted from Iran, a new producer entered the market with large quantities of oil. In
addition, growing fears about action on climate change, coupled with the emergence of alternative-energy
technologies, caused producers to pump as hard as they can, while they can.

In the industry at large, the incentive is to keep producing “as flat out as you can”, once investment costs
have been sunk into the ground, says Simon Henry, Shell’s chief financial officer. He says it is sometimes
more expensive to stop production than to keep pumping at low prices, because of the high cost of
mothballing wells. He suggested that firms will not pack up so long as prices cover day-to-day costs, in
some cases as low as $15 a barrel. It may be uneconomic to drill new deepwater wells at prices under $60
a barrel, he says, but once they are built it may still make economic sense to keep them running at prices
well below that. Such resilience is used by some to justify why they expect prices to remain “lower for
longer”.

Case Questions
1) What does this suggest about how firms will behave in the short run?
2) Based on the information given about this market, what do you think the time horizon will be for this
industry’s ‘long run’? What will happen in the long run?
3) Comment on the effects of OPEC’s actions on the market.

ACQUISITION OF NEW KNOWLEDGE (Live Lecture-Discussion via Schoology)


Contents:

Concepts of Demand
The Law of Demand
Demand Schedule and Demand Curve
Determinants of Demand
Types of Demand
Changes in Quantity Demanded VS Changes in Demand
Demand Function

APPLICATION
 Written task. In not less than 500 words and not more than 1,000 words, make an essay of the
following.
 The demand for housing in the Philippines

ASSESSMENT

 Quiz. Answer the following questions.


1) For 5 points each, identify and analyze at least 5 factors which may determine the demand for
each of the following: (15 pts.)
(a) a consumer durable item like car/washing machine
(b) an intermediate good like cables
(c) a producer good like machinery/equipment.
2) For 5 points each, distinguish between the following: (30 pts.)
(a) Extension of demand and increase in demand
(b) Contraction of demand and decrease in demand
(c) Want and demand
(d) Substitution effect and income effect
(e) Inferior goods and Giffen goods
(f) Direct and derived demand

ASSIGNMENT

For 10 points each, answer the following:

1) What are the types of elasticity of demand? Describe each.


2) What are the elasticity of demand determinants? Describe each.
3) What are the significance of elasticity of demand?

REFERENCES

Lopus, S. (2015). The principles of economics textbook. https://www.researchgate.net/publication/


268435836_The_Principles_of_Economics_Textbook

Samuelson, W. & Marks, S. (2012). Managerial economics textbook, 7th ed.


http://www.mim.ac.mw/books/Samuelson%20Managerial%20Economics%207e.pdf

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