Description
This is a presentation explaining elasticity and determinants of price elasticity of demand.
Elasticity and Its Application
Elasticity – The concept
? The responsiveness of one variable to changes in ? ? ? ?
another When price rises what happens to demand? Demand falls BUT! How much does demand fall?
Elasticity – The concept
? If price rises by 10% - what happens to demand?
? We know demand will fall
? By more than 10%? ? By less than 10%? ? Elasticity measures the extent to which demand
will change
Elasticity . . .
? … is a measure of how much buyers and sellers
respond to changes in market conditions
? … allows us to analyze supply and demand with
greater precision.
Price Elasticity of Demand
?Price elasticity of demand is the percentage
change in quantity demanded given a percent change in the price.
?It is a measure of how much the quantity
demanded of a good responds to a change in the price of that good.
Determinants of Price Elasticity of Demand
Necessities versus Luxuries Availability of Close Substitutes
?
? ?
Time Horizon
Determinants of Price Elasticity of Demand
Demand tends to be more elastic :
?if the good is a luxury. ?the longer the time period. ?the larger the number of close substitutes.
Computing the Price Elasticity of Demand
The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price.
Percentage Change in Quantity Demanded Price Elasticity of Demand = Percentage Change in Price
The Percentage Method
Computing the Price Elasticity of Demand
Price elasticity of demand ? Percentage change in quatity demanded Percentage change in price
Example: If the price of an ice cream cone increases from 2.00 to 2.20 and the amount you buy falls from 10 to 8 cones then your elasticity of demand would be calculated as:
(10 ? 8 ) ? 100 20 percent 10 ? ?2 ( 2.20 ? 2.00 ) ? 100 10 percent 2.00
Ranges of Elasticity
?
Perfectly Inelastic
Quantity demanded does not respond to price changes.
?Inelastic Demand
Quantity demanded does not respond strongly to price changes. Price elasticity of demand is less than one.
Ranges of Elasticity
?Unit Elastic
Quantity demanded changes by the same percentage as the price.
?Elastic Demand
Quantity demanded responds strongly to changes in price. Price elasticity of demand is greater than one.
?Perfectly Elastic
Quantity demanded changes infinitely with any change in price.
A Variety of Demand Curves
Because the price elasticity of demand measures how much quantity demanded responds to the price, it is closely related to the slope of the demand curve.
Perfectly Inelastic Demand
- Elasticity equals 0
Price
Demand
5 1. An increase in price... 4
Quantity 100 2. ...leaves the quantity demanded unchanged.
Inelastic Demand
- Elasticity is less than 1
Price
1. A 25% 5 increase in price... 4 Demand
Quantity 90 100 2. ...leads to a 10% decrease in quantity.
Unit Elastic Demand
- Elasticity equals 1
Price
1. A 25% 5 increase in price... 4 Demand
Quantity 75 100 2. ...leads to a 25% decrease in quantity.
Elastic Demand
- Elasticity is greater than 1
Price
1. A 25% 5 increase in price... 4 Demand
Quantity 50 100 2. ...leads to a 50% decrease in quantity.
Perfectly Elastic Demand
- Elasticity equals infinity
Price 1. At any price above 4, quantity demanded is zero. 4 2. At exactly 4, consumers will buy any quantity. 3. At a price below 4, quantity demanded is infinite. Quantity
Demand
Elasticity
Price
Total revenue is price x quantity sold. In this example, TR = 5 x 100 = 500.
This value is represented by the shaded rectangle.
The importance of elasticity is the information it provides on the effect on total revenue of changes in price.
5
Total Revenue
D 100 Quantity Demanded
Elasticity
Price
5
3
If the firm decides to decrease price to (say) 3, the degree of price elasticity of the demand curve would determine the extent of the increase in demand and the change therefore in total revenue.
Total Revenue
D
100 140 Quantity Demanded
Elasticity
Price 10
Producer decides to lower price to attract sales
% ? Price = -50% % ? Quantity Demanded = +20% Ped = -0.4 (Inelastic) Total Revenue would fall
5
Not a good move!
D
5 6
Quantity Demanded
Elasticity
Price
Producer decides to reduce price to increase sales % ? in Price = - 30% % ? in Demand = + 300% Ped = - 10 (Elastic) Total Revenue rises Good Move!
D
10 7
5
Quantity Demanded
20
Elasticity
? If demand is price ? If demand is price
elastic: ? Increasing price would reduce TR (%? Qd > % ? P) ? Reducing price would increase TR (%? Qd > % ? P)
inelastic: ? Increasing price would increase TR (%? Qd < % ? P) ? Reducing price would reduce TR (%? Qd < % ? P)
? Income elasticity of
demand =
Percentagechangein quatity demanded Percentagechangein income
? Income Elasticity of Demand:
? The responsiveness of demand to changes in
incomes.
? Normal Good – demand rises as income rises
and vice versa ? Inferior Good – demand falls as income rises and vice versa
? Cross Elasticity:
? The responsiveness of demand of one good to
changes in the price of a related good – either a substitute or a complement
__% ? in Qd of Good T_ Xed =
% ? Price of good y
Importance of Elasticity
? Relationship between changes in price and total
revenue ? Importance in determining what goods to tax (tax revenue) ? Importance in analysing time lags in production ? Influences the behaviour of a firm
Importance of Elasticity Concepts
? For a Businessman : If a businessman finds
that the demand is inelastic, he is free to increase prices. In case if the demand is elastic, by slightly reducing the price, the demand will increase sharply and hence the total revenue will also increase. ? The better a company can assess future demand, the better it can plan its resources. Each company is exposed to three types of factors influencing demand: company, competitive and macroeconomic factors.
Demand Forecasting
? A forecast is a prediction or anticipation of any
event which is likely to happen in future. ? Demand forecast is the prediction of the future demand for a firm’s product.
Forecasts are necessary for :
? Fulfillment of the objectives. ? Preparations of budgets. ? Stabilization of employment and production. ? Decisions about expansion of a firm. ? Other decisions like long term investment plans,
warehousing and inventory decisions.
Methods of Demand forecasting
? There are two different sets of methods for
demand forecasting : ? Interview & survey methods ( for short term forecasts ) ? Projection Approach ( for long term forecasts )
Interview and Survey approach
? To anticipate the demand for a product,
information needs to be collected about the expected expenditure patterns of consumers. Depending on the various approaches to collect this information, different sub – methods are formulated. ? We will study them one by one.
Interview and Survey approach
? Executive Opinion : ? In small companies, usually the owner takes the
responsibility of forecasting. ? As a result of the experience and knowledge he is expected to have, he can predict what would be the course of activities in future and plan his own activities accordingly.
Interview and Survey approach
? Opinion polling method : Information about the
consumer’s expenditure can be collected either by the market research department or through the wholesalers and retailers. ? As a result of technological advancements, it is now possible to collect this information by the means of internet.
Interview and Survey approach
? Collective opinion method :
? Jury is a group of individuals, usually the top bosses
or sales, production, marketing managers having experience in different fields. ? The advantage of this method is that instead of basing the forecast on the opinion of one single individual, a more accurate forecast can be drawn.
Interview and Survey approach
? Sample survey method :
? The total number of customers of a company is
called as its population. When this number is more, it is not possible to collect information for all the customers. When only a few customers are contacted, it is called as a Sample Survey.
User’s Expectations
Consumer and industrial companies often poll their actual or potential customers. Some Industrial manufacturers ask about the quantities of products their customers may purchase in future and take this as their forecast.
Delphi Method
Administering a series of questionnaires to panels of experts. This method gathers information from all experts and the opinion of all the experts is shared by all other experts. In case if an expert finds that his own forecast is unrealistic, after going through the opinion of other experts, there is a chance for corrections.
Projection Approach
? In this method, the past experience is projected
for the future. This can be done by tow methods : ? Correlation or regression analysis. ? Time series analysis.
Classical approach to time series analysis:
Past sales can be used to forecast future demand. Past sales are viewed from the angles of trends, various cycles of business, seasonality and then a forecast is drawn after checking the possibility of the same treads, cycles and seasonality factors. This method is easy to use, it is based on past behavior and does not include new company, competitor or macroeconomic developments.
Naïve Method
Next Year’s Sales = This Year’s Sales X This Year’s Sales Last Year’s Sales
Moving Average
Moving averages are used to allow for marketplace factors changing at different rates and at different times.
EXAMPLE OF MOVING-AVERAGE FORECAST
PERIOD 1 2 3 4 5 6
SALES VOLUME 200 250 300 350 450 ?
SALES FOR THREE-YEAR PERIOD
THREE-YEAR MOVING AVERAGE
750 900 1100 ( 3) = 300 366.6
Period 6 Forecast = 366.6
Trend Projections – Least Squares
Eyeball fitting is simply a plot of the data with a line drawn through them that the forecaster feels most accurately fits the linear trend of the data.
A TREND FORECAST OF SALES
Observed Sales 600 500 400 Trend Line
Forecast Sales
Sales
300 200 100 0 1984 1985
1986
1987 Time
1988
1989
1990
Categories of New Products
New-To-The-World
New Product Lines
Six Categories of New Products
Product Line Additions Improvements/Revisions Repositioned Products Lower-Priced Products
Forecasting of New Products
? Evolutionary method : Whenever a new
product has been evolved from an existing product ( eg. Colour TV from Black & White TV ), the information of the existing product may be used for prediction of future for the new product. ? Substitution method : Many new goods are purchased by customers for replacing the old ones. ( Eg. LCD TV’s in place of Colour TV’s).
Forecasting of New Products
? Growth pattern methods : To predict the
demand for a new product, the growth pattern of an established related goods can be understood. ? Opinion polling method : This method advocates the direct questioning to the probable buyers or the influencers of sales of such products. (Eg. demand for drugs can be ascertained by asking the doctors )
Forecasting of New Products
? Sample survey method : A product is first
introduced in a test market ( small city having profiles of customers of metros ). Responses from these markets are taken as a base for forecasts. ? Indirect opinion polling : Instead of asking the probable buyers, here, the resellers are consulted.
doc_552797129.pptx
This is a presentation explaining elasticity and determinants of price elasticity of demand.
Elasticity and Its Application
Elasticity – The concept
? The responsiveness of one variable to changes in ? ? ? ?
another When price rises what happens to demand? Demand falls BUT! How much does demand fall?
Elasticity – The concept
? If price rises by 10% - what happens to demand?
? We know demand will fall
? By more than 10%? ? By less than 10%? ? Elasticity measures the extent to which demand
will change
Elasticity . . .
? … is a measure of how much buyers and sellers
respond to changes in market conditions
? … allows us to analyze supply and demand with
greater precision.
Price Elasticity of Demand
?Price elasticity of demand is the percentage
change in quantity demanded given a percent change in the price.
?It is a measure of how much the quantity
demanded of a good responds to a change in the price of that good.
Determinants of Price Elasticity of Demand
Necessities versus Luxuries Availability of Close Substitutes
?
? ?
Time Horizon
Determinants of Price Elasticity of Demand
Demand tends to be more elastic :
?if the good is a luxury. ?the longer the time period. ?the larger the number of close substitutes.
Computing the Price Elasticity of Demand
The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price.
Percentage Change in Quantity Demanded Price Elasticity of Demand = Percentage Change in Price
The Percentage Method
Computing the Price Elasticity of Demand
Price elasticity of demand ? Percentage change in quatity demanded Percentage change in price
Example: If the price of an ice cream cone increases from 2.00 to 2.20 and the amount you buy falls from 10 to 8 cones then your elasticity of demand would be calculated as:
(10 ? 8 ) ? 100 20 percent 10 ? ?2 ( 2.20 ? 2.00 ) ? 100 10 percent 2.00
Ranges of Elasticity
?
Perfectly Inelastic
Quantity demanded does not respond to price changes.
?Inelastic Demand
Quantity demanded does not respond strongly to price changes. Price elasticity of demand is less than one.
Ranges of Elasticity
?Unit Elastic
Quantity demanded changes by the same percentage as the price.
?Elastic Demand
Quantity demanded responds strongly to changes in price. Price elasticity of demand is greater than one.
?Perfectly Elastic
Quantity demanded changes infinitely with any change in price.
A Variety of Demand Curves
Because the price elasticity of demand measures how much quantity demanded responds to the price, it is closely related to the slope of the demand curve.
Perfectly Inelastic Demand
- Elasticity equals 0
Price
Demand
5 1. An increase in price... 4
Quantity 100 2. ...leaves the quantity demanded unchanged.
Inelastic Demand
- Elasticity is less than 1
Price
1. A 25% 5 increase in price... 4 Demand
Quantity 90 100 2. ...leads to a 10% decrease in quantity.
Unit Elastic Demand
- Elasticity equals 1
Price
1. A 25% 5 increase in price... 4 Demand
Quantity 75 100 2. ...leads to a 25% decrease in quantity.
Elastic Demand
- Elasticity is greater than 1
Price
1. A 25% 5 increase in price... 4 Demand
Quantity 50 100 2. ...leads to a 50% decrease in quantity.
Perfectly Elastic Demand
- Elasticity equals infinity
Price 1. At any price above 4, quantity demanded is zero. 4 2. At exactly 4, consumers will buy any quantity. 3. At a price below 4, quantity demanded is infinite. Quantity
Demand
Elasticity
Price
Total revenue is price x quantity sold. In this example, TR = 5 x 100 = 500.
This value is represented by the shaded rectangle.
The importance of elasticity is the information it provides on the effect on total revenue of changes in price.
5
Total Revenue
D 100 Quantity Demanded
Elasticity
Price
5
3
If the firm decides to decrease price to (say) 3, the degree of price elasticity of the demand curve would determine the extent of the increase in demand and the change therefore in total revenue.
Total Revenue
D
100 140 Quantity Demanded
Elasticity
Price 10
Producer decides to lower price to attract sales
% ? Price = -50% % ? Quantity Demanded = +20% Ped = -0.4 (Inelastic) Total Revenue would fall
5
Not a good move!
D
5 6
Quantity Demanded
Elasticity
Price
Producer decides to reduce price to increase sales % ? in Price = - 30% % ? in Demand = + 300% Ped = - 10 (Elastic) Total Revenue rises Good Move!
D
10 7
5
Quantity Demanded
20
Elasticity
? If demand is price ? If demand is price
elastic: ? Increasing price would reduce TR (%? Qd > % ? P) ? Reducing price would increase TR (%? Qd > % ? P)
inelastic: ? Increasing price would increase TR (%? Qd < % ? P) ? Reducing price would reduce TR (%? Qd < % ? P)
? Income elasticity of
demand =
Percentagechangein quatity demanded Percentagechangein income
? Income Elasticity of Demand:
? The responsiveness of demand to changes in
incomes.
? Normal Good – demand rises as income rises
and vice versa ? Inferior Good – demand falls as income rises and vice versa
? Cross Elasticity:
? The responsiveness of demand of one good to
changes in the price of a related good – either a substitute or a complement
__% ? in Qd of Good T_ Xed =
% ? Price of good y
Importance of Elasticity
? Relationship between changes in price and total
revenue ? Importance in determining what goods to tax (tax revenue) ? Importance in analysing time lags in production ? Influences the behaviour of a firm
Importance of Elasticity Concepts
? For a Businessman : If a businessman finds
that the demand is inelastic, he is free to increase prices. In case if the demand is elastic, by slightly reducing the price, the demand will increase sharply and hence the total revenue will also increase. ? The better a company can assess future demand, the better it can plan its resources. Each company is exposed to three types of factors influencing demand: company, competitive and macroeconomic factors.
Demand Forecasting
? A forecast is a prediction or anticipation of any
event which is likely to happen in future. ? Demand forecast is the prediction of the future demand for a firm’s product.
Forecasts are necessary for :
? Fulfillment of the objectives. ? Preparations of budgets. ? Stabilization of employment and production. ? Decisions about expansion of a firm. ? Other decisions like long term investment plans,
warehousing and inventory decisions.
Methods of Demand forecasting
? There are two different sets of methods for
demand forecasting : ? Interview & survey methods ( for short term forecasts ) ? Projection Approach ( for long term forecasts )
Interview and Survey approach
? To anticipate the demand for a product,
information needs to be collected about the expected expenditure patterns of consumers. Depending on the various approaches to collect this information, different sub – methods are formulated. ? We will study them one by one.
Interview and Survey approach
? Executive Opinion : ? In small companies, usually the owner takes the
responsibility of forecasting. ? As a result of the experience and knowledge he is expected to have, he can predict what would be the course of activities in future and plan his own activities accordingly.
Interview and Survey approach
? Opinion polling method : Information about the
consumer’s expenditure can be collected either by the market research department or through the wholesalers and retailers. ? As a result of technological advancements, it is now possible to collect this information by the means of internet.
Interview and Survey approach
? Collective opinion method :
? Jury is a group of individuals, usually the top bosses
or sales, production, marketing managers having experience in different fields. ? The advantage of this method is that instead of basing the forecast on the opinion of one single individual, a more accurate forecast can be drawn.
Interview and Survey approach
? Sample survey method :
? The total number of customers of a company is
called as its population. When this number is more, it is not possible to collect information for all the customers. When only a few customers are contacted, it is called as a Sample Survey.
User’s Expectations
Consumer and industrial companies often poll their actual or potential customers. Some Industrial manufacturers ask about the quantities of products their customers may purchase in future and take this as their forecast.
Delphi Method
Administering a series of questionnaires to panels of experts. This method gathers information from all experts and the opinion of all the experts is shared by all other experts. In case if an expert finds that his own forecast is unrealistic, after going through the opinion of other experts, there is a chance for corrections.
Projection Approach
? In this method, the past experience is projected
for the future. This can be done by tow methods : ? Correlation or regression analysis. ? Time series analysis.
Classical approach to time series analysis:
Past sales can be used to forecast future demand. Past sales are viewed from the angles of trends, various cycles of business, seasonality and then a forecast is drawn after checking the possibility of the same treads, cycles and seasonality factors. This method is easy to use, it is based on past behavior and does not include new company, competitor or macroeconomic developments.
Naïve Method
Next Year’s Sales = This Year’s Sales X This Year’s Sales Last Year’s Sales
Moving Average
Moving averages are used to allow for marketplace factors changing at different rates and at different times.
EXAMPLE OF MOVING-AVERAGE FORECAST
PERIOD 1 2 3 4 5 6
SALES VOLUME 200 250 300 350 450 ?
SALES FOR THREE-YEAR PERIOD
THREE-YEAR MOVING AVERAGE
750 900 1100 ( 3) = 300 366.6
Period 6 Forecast = 366.6
Trend Projections – Least Squares
Eyeball fitting is simply a plot of the data with a line drawn through them that the forecaster feels most accurately fits the linear trend of the data.
A TREND FORECAST OF SALES
Observed Sales 600 500 400 Trend Line
Forecast Sales
Sales
300 200 100 0 1984 1985
1986
1987 Time
1988
1989
1990
Categories of New Products
New-To-The-World
New Product Lines
Six Categories of New Products
Product Line Additions Improvements/Revisions Repositioned Products Lower-Priced Products
Forecasting of New Products
? Evolutionary method : Whenever a new
product has been evolved from an existing product ( eg. Colour TV from Black & White TV ), the information of the existing product may be used for prediction of future for the new product. ? Substitution method : Many new goods are purchased by customers for replacing the old ones. ( Eg. LCD TV’s in place of Colour TV’s).
Forecasting of New Products
? Growth pattern methods : To predict the
demand for a new product, the growth pattern of an established related goods can be understood. ? Opinion polling method : This method advocates the direct questioning to the probable buyers or the influencers of sales of such products. (Eg. demand for drugs can be ascertained by asking the doctors )
Forecasting of New Products
? Sample survey method : A product is first
introduced in a test market ( small city having profiles of customers of metros ). Responses from these markets are taken as a base for forecasts. ? Indirect opinion polling : Instead of asking the probable buyers, here, the resellers are consulted.
doc_552797129.pptx