Module 2

Demand Analysis
Prepared by: Gayly Ann I. Tolentino, MAEd
Unit 2: Demand Analysis
LEARNING OBJECTIVES

 Define demand
 Explain demand and the law of demand
 Identify and explain a demand curve
 Create and interpret a demand curve using a data set

KEY POINTS:
 Demand does not only have to do with the need to have a product or a service, but it
also involves the willingness and ability to buy it at the price charged for it.
 The demand curve for all consumers together follows from the demand curve of every
individual consumer. The individual demands at each price are added together.
 The negative slope of the demand curve is often referred to as the “law of demand,”
which means people will buy more of a service, product, or resource as its price falls.

What is DEMAND?

When clients want a product and are willing to pay for it, we say that there is a
demand for the specific product. There has to be a demand for a product before a
manufacturer can sell it. Demand does not only have to do with the need to have a
product or a service, but also with the willingness and ability to buy it at the price
charged for it.

Economists use the term demand to refer to the amount of some good or
service consumers are willing and able to purchase at each price. Demand is based on
needs and wants—a consumer may be able to differentiate between a need and a
want, but from an economist’s perspective, they are the same thing. Demand is also
based on ability to pay. If you can’t pay for it, you have no effective demand.
What a buyer pays for a unit of the specific good or service is called the price.
The total number of units purchased at that price is called the quantity demanded. A
rise in the price of a good or service almost always decreases the quantity of that good
or service demanded. Conversely, a fall in price will increase the quantity demanded.
When the price of a gallon of gasoline goes up, for example, people look for ways to
reduce their consumption by combining several errands, commuting by carpool or
mass transit, or taking weekend or vacation trips closer to home. Economists call this
inverse relationship between price and quantity demanded the law of demand. The
law of demand assumes that all other variables that affect demand are held constant.
What is DEMAND SCHEDULE AND DEMAND CURVE?

An example from the market for gasoline can be shown in the form of a table or
a graph. A table that shows the quantity demanded at each price, such as Table 1, is
called a demand schedule. Price in this case is measured in dollars per gallon of
gasoline. The quantity demanded is measured in millions of gallons over some time
period (for example, per day or per year) and over some geographic area (like a state or
a country).

A demand curve shows the relationship between price and quantity demanded
on a graph like Figure 2, below, with price per gallon on the vertical axis and quantity
on the horizontal axis. Note that this is an exception to the normal rule in mathematics
that the independent variable (x) goes on the horizontal axis and the dependent variable
(y) goes on the vertical. Economics is different from math! Note also that each point on
the demand curve comes from one row in Table 1. For example, the upper most point
on the demand curve corresponds to the last row in Table 1, while the lower most
point corresponds to the first row.

Figure 2. A Demand Curve for Gasoline (derived from the data in Table 1).
 The demand schedule (Table 1) shows that as price rises, quantity demanded
decreases, and vice versa. These points can then be graphed, and the line connecting
them is the demand curve (shown by line D in the graph, above). The downward slope
of the demand curve again illustrates the law of demand—the inverse relationship
between prices and quantity demanded.

The demand schedule shown by Table 1 and the demand curve shown by the graph in
Figure 2 are two ways of describing the same relationship between price and quantity
demanded.

Activity 1:

TRY IT

Jamal is a small business owner who sells delivery trucks to local retailers. Last
month the price of a new truck was $32,000 and he sold a total of 16 trucks during
that month. This month the price of a new truck has increased to $35,000.
Which quantity demanded might Jamal expect to observe this month according to
the law of demand?

After Jamal increased the price of his trucks, he actually observed that his buyers
increased rather than decreased their number of vehicle purchases. While he sold 16
trucks to his customers the month before the price increase, he sold a total of 18
trucks one month later. What is the most likely explanation for this apparent violation
in the law of demand?
Activity 2:

WATCH IT

The demand curve shows how much of a good people are willing to buy at
different prices. Watch this video to see an example of the demand for oil. When oil
prices are high, fewer people are willing to pay the hefty price tag but some
consumers, like airliners, depend so heavily on using oil for fuel, they are willing to
pay a lot. Other low-value consumers will be less likely to pay for expensive oil, as
they could find substitutes or alternatives.

Click the link provided and watch the video clip. This activity will broaden your
knowledge on how demand curves will look somewhat different for each products.
They may appear relatively steep or flat, or they may be straight or curved. Nearly all
demand curves share the fundamental similarity that they slope down from left to
right. In this way, demand curves embody the law of demand: As the price increases,
the quantity demanded decreases, and conversely, as the price decreases, the quantity
demanded increases.

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They may appear relatively steep or flat, or they may be straight or curved.
Nearly all demand curves share the fundamental similarity that they slope down from
left to right. In this way, demand curves embody the law of demand: As the price
increases, the quantity demanded decreases, and conversely, as the price decreases,
the quantity demanded increases.

Activity 3:
TRY IT
1. Which of the following demand curve for tomatoes violates the law of demand?

A.
B.

C.

2. You are given the following demand schedule for used cars. Which of the following
demand curves accurately represents this demand schedule and has proper
formatting?

The demand schedule for used cars

Price ($) Quantity Demanded
1000 7600
2000 6500
3000 5400
4000 4300
5000 3200
6000 2100
7000 1000
8000 300
A.

B.

C.
 Demand versus Quantity Demanded

In economic terminology, demand is not the same as quantity demanded. When

economists talk about demand, they mean the relationship between a range of prices
and the quantities demanded at those prices, as illustrated by a demand curve or a
demand schedule. When economists, talk about quantity demanded, they mean only
a certain point on the demand curve, or one quantity on the demand schedule. In
short, demand refers to the curve and quantity demand refers to the (specific) point on
the curve.

What Factors Affect Demand?

We defined demand as the amount of some product that a consumer
is willing and able to purchase at each price. This suggests at least two factors, in
addition to price, that affect demand. “Willingness to purchase” suggests a desire to
buy, and it depends on what economists call tastes and preferences. If you neither
need nor want something, you won’t be willing to buy it. “Ability to purchase” suggests
that income is important. Professors are usually able to afford better housing and
transportation than students, because they have more income. The prices of related
goods can also affect demand. If you need a new car, for example, the price of a Honda
may affect your demand for a Ford. Finally, the size or composition of the population
can affect demand. The more children a family has, the greater their demand for
clothing. The more driving-age children a family has, the greater their demand for car
insurance and the less for diapers and baby formula.

These factors matter both for demand by an individual and demand by the
market as a whole. Exactly how do these various factors affect demand, and how do
we show the effects graphically? To answer those questions, we need the ceteris
paribus assumption.

Ceteris Paribus Assumption

A demand curve or a supply curve (which we’ll cover later in this module) is a
relationship between two, and only two, variables: price on the vertical axis and
quantity on the horizontal axis. The assumption behind a demand curve or a supply
curve is that no relevant economic factors, other than the product’s price, are
changing. Economists call this assumption ceteris paribus, a Latin phrase meaning
“other things being equal.” Any given demand or supply curve is based on the ceteris
paribus assumption that all else is held equal. Therefore, a demand curve or a supply
curve is a relationship between two, and only two, variables when all other variables
are held equal. If all else is not held equal, then the laws of supply and demand will
not necessarily hold.
Activity 4:
TRY IT
Below is the demand curve for oranges in a Florida supermarket. Select the demand
schedule that best corresponds to this demand curve.

A. B.

C.
2. You are the chief data analyst of the U.S. Fish and Wildlife Service for the Northeast
region. Recently the agency has become concerned about overfishing in the North
Atlantic fisheries, and you are charged with estimating the demand curve for tuna as
part of the agency’s mitigation efforts.
From public surveys you know that when the price of a freshly caught tuna is $400,
the public will demand a quantity of 1 million fish. If the price is $275 then the public
will demand 4 million fish. Finally, if the price was $185 consumers will demand a
quantity of 8 million fish.
Which curve below could be the correct demand curve for North Atlantic tuna given
these three data points?
 WHEN DOES CETERIS PARIBUS APPLY?

Ceteris paribus is applied when we look at how changes in price affect demand
or supply, but ceteris paribus can also be applied more generally. In the real world,
demand and supply depend on more factors than just price. For example, a
consumer’s demand depends on income, and a producer’s supply depends on the cost
of producing the product. How can we analyze the effect on demand or supply if
multiple factors are changing at the same time—say price rises and income falls? The
answer is that we examine the changes one at a time, and assume that the other
factors are held constant.

For example, we can say that an increase in the price reduces the amount
consumers will buy (assuming income, and anything else that affects demand, is
unchanged). Additionally, a decrease in income reduces the amount consumers can
afford to buy (assuming price, and anything else that affects demand, is unchanged).
This is what the ceteris paribus assumption really means. In this particular case, after
we analyze each factor separately, we can combine the results. The amount
consumers buy falls for two reasons: first because of the higher price and second
because of the lower income.

WATCH IT

Watch this video to review the theory of demand. Remember that, according to the law
of demand and all other things being equal (ceteris paribus):

 the lower the price of a product, the more of it will be bought

 the higher the price of a product, the less of it will be bought

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 ELASTICITY OF DEMAND
Elasticity of demand is a measure used in economics to show the
responsiveness of the quantity demanded of an item to a change in its price.

KEY POINTS:
 Price elasticities are almost always negative; only goods which do not conform to
the law of demand, such as a Veblen good and a Giffen good, have a positive PED.
 In general, the demand for a good is said to be inelastic (or relatively inelastic)
when changes in price have a relatively small effect on the quantity of the good
demanded.
 The demand for a good is said to be elastic (or relatively elastic) when changes in
price have a relatively large effect on the quantity of a good demanded.
 A number of factors can thus affect the elasticity of demand for a good.

Elasticity of Demand: an Overview

Price elasticity of demand (PED or Ed) is a measure used in economics to show the
responsiveness, or elasticity, of the quantity demanded of a good or service to a
change in its price.

More precisely, it gives the percentage change in quantity demanded in response to a

one percent change in price (holding constant all the other determinants of demand,
such as income). It was devised by Alfred Marshall.

Elasticity of Demand: The price elasticity of demand equation shows how the
demand for a good or service changes based on the price.

Price elasticities are almost always negative, although analysts tend to ignore the sign
even though this can lead to ambiguity. Only goods which do not conform to the law of
demand, such as a Veblen good and a Giffen good, have a positive PED.

In general, the demand for a good is said to be inelastic (or relatively inelastic) when
the PED is less than one (in absolute value): that is, changes in price have a relatively
small effect on the quantity of the good demanded.
The demand for a good is said to be elastic (or relatively elastic) when its PED is
greater than one (in absolute value): that is, changes in price have a relatively large
effect on the quantity of a good demanded.

Revenue is maximized when price is set so that the PED is exactly one. The PED of a
good can also be used to predict the incidence (or “burden”) of a tax on that good.
Various research methods are used to determine price elasticity, including test
markets, analysis of historical sales data, and conjoint analysis.

Determinants

The overriding factor in determining PED is the willingness and ability of consumers
after a price change to postpone immediate consumption decisions concerning the
good and to search for substitutes (“wait and look”). A number of factors can thus
affect the elasticity of demand for a good:

 Availability of substitute goods: The more and closer the substitutes available,
the higher the elasticity is likely to be, as people can easily switch from one good
to another if an even minor price change is made. In other words, there is a
strong substitution effect. If no close substitutes are available, the substitution
of effect will be small and the demand inelastic.
 Breadth of definition of a good: The broader the definition of a good (or service),
the lower the elasticity. For example, Company X’s fish and chips would tend to
have a relatively high elasticity of demand if a significant number of substitutes
are available, whereas food in general would have an extremely low elasticity of
demand because no substitutes exist.
 Percentage of income: The higher the percentage of the consumer’s income that
the product’s price represents, the higher the elasticity tends to be, as people will
pay more attention when purchasing the good because of its cost. The income
effect is thus substantial. When the goods represent only a negligible portion of
the budget, the income effect will be insignificant and demand inelastic.
 Necessity: The more necessary a good is, the lower the elasticity, as people will
attempt to buy it no matter the price, such as in the case of insulin for those
that need it.
 Duration: For most goods, the longer a price change holds, the higher the
elasticity is likely to be, as more and more consumers find they have the time
and inclination to search for substitutes. When fuel prices increase suddenly, for
instance, consumers may still fill up their empty tanks in the short run, but
when prices remain high over several years, more consumers will reduce their
demand for fuel by switching to carpooling or public transportation, investing in
vehicles with greater fuel economy, or taking other measures. This does not hold
for consumer durables such as the cars themselves, however; eventually, it may
become necessary for consumers to replace their present cars, so one would
expect demand to be less elastic.
  Brand loyalty: An attachment to a certain brand—either out of tradition or
because of proprietary barriers—can override sensitivity to price changes,
resulting in more inelastic demand.
 Who pays: Where the purchaser does not directly pay for the good they consume,
such as with corporate expense accounts, demand is likely to be more inelastic.

Key Terms
 Veblen good: A good for which people’s preference for buying them increases as a
direct function of their price, as greater price confers greater status. As the price
gets higher, demand rises.
 conjoint analysis: Conjoint analysis is a statistical technique used in market
research to determine how people value different features that make up an
individual product or service.
 Giffen good: A good which people consume more of as the price rises; Having a
positive price elasticity of demand. As price rises, more is consumed which
increases demand.

WATCH IT

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GLOSSARY

ceteris paribus:
When changing one variable in a function (e.g. demand for some product), we
assume everything else held constant

demand:
the relationship between the price of a certain good or service and the quantity
of that good or service someone is willing and able to buy

demand curve:
a graphic representation of the relationship between price and quantity
demanded of a certain good or service, with price on the vertical axis and
quantity on the horizontal axis

demand schedule:
a table that shows the quantity demanded for a certain good or service at a
range of prices

law of demand:
 the common relationship that a higher price leads to a lower quantity
demanded of a certain good or service and a lower price leads to a higher
quantity demanded, while all other variables are held constant

price:
what a buyer pays for a unit of the specific good or service

quantity demanded:
the total number of units of a good or service consumers wish to purchase at a
given price

References:
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