Demand Theory-Managerial Economics

Theory of Demand

Presented by :Ashutosh MishraMBA- Ist. Semester

If necessity is the mother of invention, then demand

is the mother of production.

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Leon Walras (1834-1910) a French economist, gave demand theory as a fundamental principle of microeconomics which gives the analysis of the relationship between the demand for goods or services and prices or incomes.

The theory was subsequently developed by English economist Alfred Marshall (1842-1924), Italian Vilfredo Pareto (1848-1923), Soviet Eugen Slutsky (1880-1948), American Kenneth Arrow (1921- ) and the French-born Gerard Debreu (1921- ).

-economyprofessor.com

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Demand is the basis of all productive activities. Demand theory is an economic theory that concerns the relationship between the demand for goods and their prices; it forms the core of microeconomics.

The generation of demand can be pictorially shown as below,

NEED WANT DEMAND

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Concept of effective demand

Want Demand

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Demand

Law of Demand Hedonic theory

The law of demand is normally depicted as an inverse relation of quantity demanded

and price: the higher the price of the

product, the less the consumer will

demand, ceteris paribus ("all other

things being equal").

It is an economic theory that the price an individual will pay

for a good reflects the sum of the

characteristics of that good.

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Demand Schedule: A demand schedule is a tabular presentation of the amount of goods consumers are willing and able to buy at different level of prices over a given period of time.

Demand Curve: The graphical representation of demand schedule is the demand curve. The demand curve is a downward sloping curve from left to right. This characteristic of the demand curve is due to the inverse relationship between price and quantity demanded.

Price per cassette Rs.

ABCDE

A Demand Table

DVD rentals demanded per

week

0.501.002.003.004.00

98642 P

rice

per

DV

Ds

(in

ru

pee

s)E

D

C

BA

G

1 2 3 4 5 6 7 8 9 10Quantity of DVDs demanded (per week)

Demand for DVDs

6.00A Demand Curve

5.00

4.003.50

3.00

2.00

1.00

.50 F

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Reasons behind Demand

The Income Effect: There is an income effect when the price of a good falls because the consumer can maintain current consumption for less expenditure.

The Substitution Effect: There is also a substitution effect when the price of a good falls because the product is now relatively cheaper than an alternative item and so some consumers switch their spending from the good in competitive demand to this product.

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Conditions of Demand

The conditions of demand for a product in a market can besummarized as follows:D = f (Pn, Pn…Pn-1, Y, T, P, E)Where: Pn = Price of the good itselfPn…Pn-1 = Prices of other goods – e.g. prices of Substitutes andComplementsY = Consumer incomes – including both the level and distributionof incomeT = Tastes and preferences of consumersP = The level and age-structure of the populationE = Price expectations of consumers for future time periods

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Exceptions to the Law of Demand

ostentatious consumption effects of speculative demand

The demand for theproduct is a directfunction of its price. Itcomprises of luxuryitems. They are calledVeblen goods.Eg. Expensiveperfumes, designerclothes etc.

The potential buyers are interested not just in the satisfaction they may get

from consuming the product, but also the

potential rise in market price leading to a capital

gain or profit.Eg. Housing & shares etc.

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Integrability & Aggregation in Theory of Demand

Harold Hotelling believed that integrability was a necessary characteristic of both individual and market demand equations, and he demonstrated that it would hold if consumers did not have a budget constraint. If there was a budget constraint, he contended, the usual integrabilitycondition would be replaced by a condition which assures that an integrating factor can be introduced.

Aggregation by summation of individual demands is considered, and it is shown that this form of aggregation is valid if there is a budget constraint only when income effects are the same for all individuals.

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Demand Shocks

A model of business cycles driven by shocks to consumer expectations regarding aggregate productivity. Agents are hit by heterogeneous productivity shocks, they observe their own productivity and a noisy public signal regarding aggregate productivity.A calibrated version of the model is able to generate realistic amounts of short-run volatility due to demand shocks, in line with existing time-series evidence.

Guido LorenzoniMIT Department of EconomicsE52-251C50 Memorial DriveCambridge, MA 02142 and NBER.

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MASSIVE DROP IN U.S. DEMAND IN APRIL

U.S. oil demand in April was 863,000 barrels per day less than previously estimated and down 811,000 bpd from a year earlier, putting petroleum consumption at the lowest level for any April month in six years, the Energy Information Administration said on Monday.The lower oil demand was due to rising fuel prices and a faltering U.S. economy that has cut into petroleum use.The size of this drop (down 811,000bpd, year-on-year) is massive. Indeed it's almost enough to wipe out total worldwide growth in oil consumption from 2006 to 2007 (990,000bpd, according to the BP Statistical Review 2008).

Monday, June 30, 2008-Reuters Washington

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It is enough to wipe out two years worth of consumption growth from China.

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The benefits a person gets from a product depend on his goals.

These goals are referred to in many ways in discussions of demand.

The words "tastes," "wants," "needs," "preferences" and "usefulness"

all refer to goals. When people's goals change, the amount of benefit

they get from the good changes, and this will cause them to change

the amount of the good they want to buy.

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It differs from being to being !

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Thank You !