Chapter 5

Chapter 5 - Understanding Consumer Demand Consumer Demand...

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Unformatted text preview: Understanding Consumer Demand Consumer Demand Consumer Demand At the heart of every economic system is the demand for goods and services. In a free enterprise system, the consumer determines what is to be produced by what he buys. The producer must correctly identify the needs of the consumer and fill these quickly and effectively. It is the combination of consumer demand and producer responses that drive our economy. In this economy, the consumer is king. Basics of Consumer Demand Scarcity Price Price allocates scare resources Two principles of consumer behavior Consumers Consumers always select the item that g gives y highest level satisfaction (utility maximization) Additional Additional satisfaction from consumption of each additional unit declines (diminishing marginal utility) 1 Factors Influencing Consumer Demand What does demand mean? What does the law of demand mean? Factors Influencing Consumer Demand Seven factors affecting the demand Price Price of product Price Price of competitor’s products (substitute (substitute products) Price Price of complement goods Income Income Population Population Taste Taste and preferences Seasonality Seasonality Movement Along Demand Curve An important element in understanding consumer demand is to recognize the difference between regular movements along the demand schedule and shifts in the demand the demand schedule and shifts in the demand schedule. schedule. Movement Movement along the Curve -- a change in price due to a change in quantity demanded 2 Shift in Demand Curve A shift in demand results in a new demand -- here we will be selling more or less at same prices. Shifts Shifts in demand are important to producers because they represent significant changes in demand. Demand shifters include changes in population Demand shifters include changes in population, consumer tastes and preferences, income, price of substitute goods, and price of complements Demand Shifters Price Price $1 $2 $3 $4 $5 Quantity 1 50 40 30 20 10 Quantity 2 60 50 40 30 20 Q2 Q1 $5 $4 $3 Demand shifters • Population • Consumer taste and preference • Income • Price of substitutes • Price of complements, etc $2 $1 10 20 30 40 50 Quantity Derived Demand DERIVED DEMAND -- The demand for one item that is largely determined by the demand for another item. The The consumer helps determine the demand for dairy barns, catfish processing plants, fertilizer dealers, etc. In In this context, the farmer's demand for fertilizer is derived partially from consumer's demand for turkeys. If consumers demand more turkey which encourages larger turkey flocks, this leads to a greater demand for corn as feed which leads to a greater amount of fertilizer needed to grow the corn. Consumer Consumer demand influences not only the product but also the various stages of production and major inputs. 3 Demand Elasticity What is Elasticity? Classifying sales response Elastic Elastic Inelastic Unitary Price Elasticity Ep = % change in quantity % change in price Price Elasticity Example: Price of caviar increases from $20 to $25 per pound and quantity demand declines from 100 pounds to 50 pounds, What is the price elasticity of caviar? Ep = % change in quantity of caviar % change in price of caviar -50% = +25% = -2 What this tells a business manager? 4 Example - Elasticity of Demand If If the price of shrimp changes from $4.00 to $5.00 per pound (a 25 percent increase) and the quantity demanded declines from 10,000 pounds to 5,000 pounds (a 50 percent decrease) own price elasticity for shrimp is: Ep = = -50% 25% Percent Change in quantity Percent Change in Price = -2 OwnOwn-Price Elasticity Magnitude Elastic Unitary Inelastic ⏐Ep⏐ > 1 ⏐Ep⏐ = 1 ⏐Ep⏐ < 1 Increase in Price: Decreased Revenue Constant Revenue Increased Revenue Decrease in Price: Increased Revenue Constant Revenue Decreased Revenue CrossCross-Price Elasticity Ecp = % change in quantity % change in price of a competitor’s or complementary product 5 CrossCross-Price Elasticity Example: Price of cracker increase from $0.50 to $1.00 per pound and caviar sales decrease from 100 pounds to 80 pounds, What is cross- price elasticity of caviar to crackers? % change in quantity of caviar % change in price of crackers -20% = +100% = -0.2 Ecp = What this tells a business manager? CrossCross-Price Elasticity Example Cross price elasticity is the responsiveness of the quantity demanded when the price of another good changes. Assume that as the price of shrimp increases 25%, the quantity of crawfish increases by 10%. The cross price elasticity is: Ep = = 10% 25% % Change in quantity of Crawfish % Change in Price in Shrimp = 0.4 CrossCross-Price Elasticity Example Consider hamburgers and french fries. Assume that the price of hamburgers increases by 30%, and with this the quantity of french fries declines by 15 %. The cross - price elasticity is computed to be: Ecp = = 15% 30% % Change in quantity of french fries Change in quantity of french % Change in Price of hamburgers = 0.5 Thus, for each 1% increase in price of hamburgers, quantity of french fries declines by 0.5% 6 CrossCross-Price Elasticity Magnitude Substitutes Complements Ep > 0 0 > Ep Increase in Price of Other Good: Increased Quantity of Own Good Decreased Quantity of Own Good Income Elasticity Ey = % change in quantity % change in income change in income Income Elasticity Example: Consumers increase from $30,000 to $33,000 and Caviar sales increased from 100 pounds to 120 pounds, What is the income elasticity of caviar? % change in sales of caviar % change in income +20% = +10% = +2 Ey = What this tell a business manager? 7 Income Elasticity Magnitude Increase in Income: Increased EI > 1 Demand 1 ≥ EI ≥ 0 Increased Demand Decreased 0 > EI Demand Decrease in Income: Decreased Demand Decreased Demand Increased Demand Superior Normal Inferior Elastic Demand & Price Change When demand is elastic, price increase results in an decrease in total revenue, while a price increase results in a increase in total revenue. Assume price of $6 and quantity of 20 units versus $8 and a quantity of 12. The elasticity is computed at – 1.2. The change in total revenue is: BEFORE $6 X 20 UNITS = $120 AFTER $8 X 12 UNITS = $ 96 LOSS $24 Relationship Between Price, Total Revenue, and Elasticity Ep <1 Elasticity Inelastic Effect on total revenue Price rise total revenue up Price decline total revenue down Price rise total revenue unchanged Price decline total revenue unchanged Price rise total revenue down Price decline total revenue up =1 Unitary >1 Elastic 8 Why Demand for a Single Food is Elastic Price E D C B A 0 Sales (Quantity demanded) A: all food items B: all dairy product C: all ice cream D: all vanilla ice cream E: Haagen-Dazs vanilla ice cream Discussion Topics 1. Explain how the combination of the consumers’ desire for utility maximization and the scarcity of resources available to meet them leads to competition in the marketplace and greater happiness by all members of society. Define the terms utility, marginal utility, and the principle of declining marginal utility as used by economists. Explain how these terms lead to people consuming spinach people consuming spinach. Explain why price is the best allocator of resources in a free market. Explain how price allocates non-scarce resources in a free market. nonExplain why economists made a distinction between consumers who are willing to and able to buy a product when they talk about effective demand. 2. 3. 4. 5. Explain why the law of demand makes sense for consumers who are always seeking to maximize their total utility from the products they consume. When is consumer demand fully satisfied? Identify and explain the factors that influence consumer demand. Which indicate a shift in consumer demand? Explain why shifts in consumer demand are important to agribusiness managers. What should a manager do if a shift in consumer demand for his or her product is found? Explain why a manager of a fertilizer company needs to pay attention to changes in consumers’ demand for chicken dinners with mashed potatoes, and the value of the dollar in foreign currency exchanges? Explain why an agribusiness manager should know if the demand for his or her products is elastic or inelastic. How does it help the firm achieve higher profits? 6. 7. 8. 9 9. What does it mean to an agribusiness firm to find out the income elasticity of its products is positive but less than one? How does this influence the formulation of the firm’s marketing plan and marketing mix? Since few substitute goods exists for food, why don’t farmers just raise prices in order to get themselves a decent income? Do you agree or disagree with this statement? Explain your answer. 10. 10 ...
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This note was uploaded on 11/03/2009 for the course AGEC 1003 taught by Professor Detre during the Fall '09 term at LSU.

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