Theory of Demand and Demand Curve

Theory of Demand:

Chapter Summary:

A demand curve displays the quantity demanded as a function of price, other things equivalent. Usually, the demand curve slopes downward. Modifications in price are symbolized by movements all along the demand curve, whereas modifications in other factors, like income, prices of related products, and advertising, are symbolized by shifts of the whole demand curve. The market demand curve is horizontal summation of the individual demand curves of different buyers.

For a normal (or inferior) product, demand is positively (or negatively) associated to modifications in buyer’s income. Two products are complements (or substitutes) when an increase in the price of one causes a fall (or increase) in the demand for the other. Buyer excess is the difference between a buyer’s total profit from some amount of purchases and his or her actual expenses. Modifications in price influence buyer excess via the price modify themselves and also via changes in the quantity demanded.

Package deals comprised of a fixed quantity of item for a fixed payment. Two-part tariffs comprise of a fixed payment and a charge based on the usage. These are two ways by which the sellers can extract excess from buyers. 
 
Key Concepts:

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General Chapter Objectives:

A) Explain a demand curve and differentiate an individual and market demand curve.

B) Demonstrate how the demand curve can be employed to:

•    Display the quantity demanded at a specific price, and
•    The price, the buyer(s) are willing to reimburse for a specific quantity.

C) Explain the relationship between the slope of a demand curve and the marginal benefit.

D) Differentiate between the change in quantity demanded Vs a change in demand in words, and also how all are reflected graphically.

E) Deduce and graphically reflect an increase and decrease in demand and explain some of the common variables which can cause an increase and decrease in demand. In specific, differentiate complements from substitutes.

F) Make a market demand curve from an individual demand curves.

G) Explain the role of income distribution in influencing the demand for products.

H) Explain buyer surplus and state it graphically.

I) Explain the concepts of package deals and two-part tariffs, and display graphically how sellers can employ such schemes to extract buyer excess.

J) Relate the perception of consumer demand to business demand for inputs and explain some factors of business demand.
 
Notes:

A) Consumer demand: Individual demand curve.

(i) A graph exhibiting the quantity that is, horizontal axis (example: number of movies watched per month) that one buyer is willing and capable to purchase at each and every possible price (that is, vertical axis) (example: ticket price per movie).

(ii) By exhibiting the maximum price, the buyer is willing and capable to pay to get each unit (or a specific quantity) of the item, the individual demand curve aids a seller to find out the maximum that a buyer is willing to pay for any particular quantity.

(iii) The demand is dependent on time.

(iv) Principle of reducing marginal benefit.

Marginal benefit: the (monetary or psychic) benefit given by an additional unit of item.

The principle of reducing marginal benefit: each extra unit of consumption or usage gives less advantage than the proceeding unit. Accordingly, the price which an individual is willing to pay will reduce with the quantity purchased.

Reducing marginal benefit gives increase to a downward sloping marginal benefit curve and a similar downward sloping demand curve: the lower the price, the bigger the quantity demanded.

(v) The process for constructing a demand curve relies totally on the consumer's individual preferences and this consists of two implications:

• The demand curve will alter with modifications in the consumer's preferences, and 
• Different consumers might contain different preferences and therefore different demand curves.

B) Changes in the income or other factors in respect of change in the price on individual demand.

(i) A modification in the price of an item (having income and all other factors unaffected) usually causes movement all along an individual demand curve (that is, a change in the quantity demanded).

(ii) The change in income or other factors (example: the prices of associated products, advertising, weather, season and place) other than the price of an item causes a whole shift of the individual demand curve (that is, a change in demand at each and every price level).

(iii) Income changes:

• Change in income will influence individual demand at each and every price levels.

• Normal products: demand rises as buyer’s income rises, and demand falls as buyer’s income falls. Whenever the economy is growing and income rising, demand for normal products will increase and demand for inferior products will go down. The demand for normal products is relatively greater in richer countries.

• Inferior products: demand is negatively related to buyer’s income. Demand rises as buyer’s income reduces, and demand drops as buyer’s income rises. In a recession, where incomes are diminishing, demand for normal products will drop and demand for inferior products will increase. The demand for inferior products is relatively greater in poorer countries.

• Broad categories (example: transportation, movies, consumer products tend to be normal, whereas specific products in the categories (example: matinees, public transport, black and white TVs) might be inferior.

• Difference between inferior and normal products is significant for business strategy and international business.

(iv) Prices of related products:

• Complements: two products are complements when a raise in the price of one causes a fall in the demand for the other; example: movies and popcorn.
• Substitutes: a raise in the price of one cause an increase in the demand for other; example: video rentals.
• In common, when there is a raise in the price of a complement or a drop in the price of a substitute, the demand curve moves to the right.

(v) Advertising:

  • Advertising might be informative and also persuasive.
  • A raise in advertising expenses usually raises individual demand.
  • The consequence of advertising expenses on demand might be subject to reducing marginal product-each extra dollar spent on advertising has a comparatively smaller consequence on demand. 

Note: Three factors (in addition to income, price, the prices of complements and substitutes, and advertising) are particularly noteworthy in the individual demand for consumer durables (example: home appliances, automobiles and machinery): expectations regarding interest rates, future prices and incomes, and the prices of utilized models.
 
C) Consumer demand: Market demand curve.

(i) A graph exhibiting the quantity which all buyers will purchase at each and every possible price. This is the horizontal summation of individual demand curves.

(ii) It allows businesses to understand the whole market instead of individual customers.

(iii) All consumers get reducing marginal benefit: the individual demand curve slopes downward, and the market demand curve as well slopes downward. At a lower price, the market as an entire will buy a bigger quantity.

D) Changes in income or other factors in respect of a modification in price on market demand.

(i) A change in price of an item (having income and all other factors unaffected) usually causes movement all along the market demand curve from one point to other on similar curve.

(ii) The change in income or other factors (example: the prices of associated products, and advertising) other than the price of an item causes a shift/move of the whole market demand curve.

(iii) The directions of consequences of changes in income and other factors on market demand are identical to those for individual demand.

(iv) Comparing the market demands in various countries:

• Two ways of evaluating the income of a whole country: the gross national product (GNP = GDP + income from the foreign sources) and the gross domestic product (GDP = total value of production).

• General shortcut in evaluating demand: by predicting the demand for an individual with average income (that is, dividing the GNP or GDP by population) and multiply that by the no. of buyers.

• However, the more uneven the distribution of income in a market, the more significant it is to consider the real distribution of income and not just the average income.
 
E) Market Structure:

(i) The concept of individual demand curve has two probable meanings: the individual demand curve of a buyer or individual demand curve faced by a seller (that is, as market demand splits into the demands facing individual sellers).

(ii) The quantity demanded for a firm's production based on the selling price, buyer’s incomes, the prices of associated products, and other factors.
 
F) Buyer surplus:

(i) Since the individual demand curve exhibits the quantity which one buyer is willing and capable to purchase at each and every possible price, a seller can compute the maximum price which the buyer can be charged for a specified purchase.

(ii) Benefit:

• Marginal benefit: the benefit given by an additional unit of the item, measured by the maximum amount which the buyer is willing to pay for that unit.

• Total benefit: the benefit yielded by each and every unit which the buyer purchases, that is, the marginal benefit from the first up to and comprising the last unit purchased. Graphically this is the region beneath the buyer's demand curve up to a comprising the last unit purchased. This is the utmost which the buyer is willing to pay for that quantity; this is as well the maximum price which a seller can charge.

G) Individual buyer surplus:

(i) The dissimilarity between an individual buyer's net benefit from certain quantity of purchases and her/his real expenditure.

(ii) Graphically reflected by the region beneath the demand curve and above the price.

(iii) Price reduction leads to rise in buyer’s surplus: first, a lower price on the quantity that the buyer would encompass purchased at the initial higher price; and second, as the buyer buys more (based on the buyer’s response to the price decrease), she gains buyer excess on each of the extra purchases.

(iv) The buyer loses from a price raise: a higher price and a decrease in the quantity purchased.

(v) The seller can extract buyer excess by the following:

• Package deal 
• Two-part tariff: a pricing scheme comprising of a fixed payment and a charge depend on usage (example: telephone monthly charge coupled with an air-time charge).

H) Business demand:

(i) Consumer in respect of business demand.

• Various items are purchased just by businesses (that is, as inputs for the production of other services and goods for sale to consumers or other businesses), example: TV commercials, and human resources.
• Various items are purchased by both the consumers (that is, for final consumption) and businesses, example: gasoline and telephone calls.
• The inputs purchased by a business can be categorized into raw materials, labor, energy and capital, which might be complements or substitutes.

(ii) The principles of business demand are identical to such underlying consumer demand.

(iii) Reducing marginal benefit:

  • The business can measure its marginal benefit from an input as the raise in revenue arising from an extra unit of the input, and will be subject to reducing marginal benefit.
  • The demand curve for an input by a business slopes down-ward due to the reducing marginal benefit from input.
  • Business demand is derived from the computations of marginal benefit. A business must buy an input up to the quantity which its marginal benefit make the input precisely balances the price.

(iv) A change in price of an input is symbolized by a movement all along the demand curve.

(v) Modifications in other factors will lead to the shift of whole demand curve.

  • The main factor in consumer demand is income. Business demand doesn’t depend on income but instead on the quantity of output. 
  • The demand for an input as well depends on the prices of complements and substitutes in the production of output.
  • On whole, purchasing decisions of businesses are relatively less subject to impulse buying than those of consumer’s therefore advertising plays a smaller role in business demand, and there is relatively extra informative than persuasive advertising.

Question-Answer:

Jupiter Hotel has two main sources of revenue: room rental and food and beverage sales.  Recently, Jupiter raised its room rates. The hotel’s occupancy rate (that is, percentage of rooms rented) fell. The room service and restaurant sales too fall.

i) Draw a demand curve for rooms at Jupiter.
ii) How did the raise in room rates influence the buyer surplus of Jupiter’s customers?
iii) Sketch a demand curve for meals at Jupiter’s restaurant.
iv) How did the raise in room rates influence the demand for restaurant meals?
 
Answer:

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(i) Demand for rooms: The figure above.

(ii) Reduction in buyer surplus: The shaded region in figure above.

(iii) Demand for meals: The figure shown it.

(iv) Reduction in demand: Look demand shift in the figure above. Restaurant meals are a complement to rooms. Therefore, the raise in room rates caused the demand for meals to shift/move to the left.

 

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