Sources of Demand

MANEC 387
Economics of Strategy

David J. Bryce
David Bryce 1996-2002
Adapted from Baye 2002

Exercise
I will name possible prices for a Reeses
As I name a price, please tell me how many
Reeses you are willing to purchase at that
price, right now.
This exercise is an offer to sell and it is real. I
reserve the right to call in the cash from any
individual at any time who indicates their
willingness to buy (you can bring me the cash
later if you dont have it on hand!).
David Bryce 1996-2002
Adapted from Baye 2002

Class Demand For Reeses

$1.00

Price

$0.75

$0.50

$0.25

$0.00
0

Quantity Demanded
David Bryce 1996-2002
Adapted from Baye 2002

Market Demand Curve

Shows the amount of a good that will
be purchased at alternative prices.
Law of Demand
The demand curve is downward sloping.
Price

Quantity
David Bryce 1996-2002
Adapted from Baye 2002

Determinants of Demand

Income
Prices of substitutes
Prices of complements
Advertising
Population changes
Consumer expectations

David Bryce 1996-2002

Adapted from Baye 2002

The Demand Function

An equation representing the demand
curve

Qxd = f(Px , PY , M, H,)

Qxd = quantity demand of good X.
Px = price of good X.
PY = price of a substitute good Y.
M = income.
H = any other variable affecting demand
David Bryce 1996-2002
Adapted from Baye 2002

Change in Quantity Demanded

Price
A to B: Increase in quantity

demanded

10

D0
4
David Bryce 1996-2002
Adapted from Baye 2002

Quantity

What could lead to a change in

quantity demanded?
Only a change in price
Why?
Because a given demand curve simply reflects
preferences under a given set of conditionsit is a
picture of stationary preferences
When conditions change, preferences often do as
well, so that the entire relationship of quantity to
price also changes (shift in demand)

David Bryce 1996-2002

Adapted from Baye 2002

Change in Demand
Price

D0 to D1: Increase in

Demand

6
D1

D0
7
David Bryce 1996-2002
Adapted from Baye 2002

13

Quantity

What could lead to an increase in

demand (shift in demand)?
A change in any of the determinants of
demand:

Income
Prices of substitutes
Prices of complements
Advertising
Population changes
Consumer expectations

A change in the quality or characteristics of a

product, even if the changes are small
David Bryce 1996-2002
Adapted from Baye 2002

Where do demand curves come

from?
Experiments
Raise and lower price systematically over time and
watch what happens to quantity
Limitation: hard to control for changes in external
factors (you may get a wiggly curve!)

Market Research
Surveys in which consumers are asked to tradeoff
bundles of goods against price or other bundles in order
to determine relative value and demand at given prices
Limitation: Expensive; sampling bias; perception bias
spending real money is different than checking boxes on
a survey
David Bryce 1996-2002
Adapted from Baye 2002

Where do demand curves come

from?
Regression analysis
Attempt to glean from multiple observations in multiple
settings (geographic, store, product, etc.) the
relationship between price and quantity
Not always goods that are exactly like
Do not always have observations on the extremes of the
curveextrapolation required

Must control for the amount supplied (otherwise may

get an upward sloping demand curve!)
Limitation: Data is hard to get and you must assume
that external factors are stable across observations or
control for these in the statistics; CAUTION: If you dont
know what youre doing, you could go wildly astray
David Bryce 1996-2002
Adapted from Baye 2002

Where do demand curves come

from?
If all else fails Use Intuition
Sniff the market by looking at how other similar
products seem to be doing
Ask your close friends and neighbors how much
they would pay
Pray about it (Limitation: faith)
Any other possible qualitative approach you can
think of
Believe it or not, youre likely to get close and
others are doing the same thing in practice

Bottom line: No technique is fool-proof!

David Bryce 1996-2002
Adapted from Baye 2002

Consumer Surplus the value consumers

get from a good but do not have to pay for

I got a lousy deal!

That car dealer drives a
That company offers a lot
hard bargain!
of bang for the buck!
I almost decided not to
buy it!
Dell provides good value.
They tried to squeeze the
Total value greatly
very last cent from me!
exceeds total amount
Total amount paid is close
paid.
to total value.
Consumer surplus is large. Consumer surplus is low.

I got a great deal!

David Bryce 1996-2002

Adapted from Baye 2002

Consumer Surplus:
The Discrete Case
Price
10

Consumer Surplus: the

value received but not
paid for

8
6
4

D
1

David Bryce 1996-2002

Adapted from Baye 2002

Quantity

Consumer Surplus:
The Continuous Case
Price $
10

Value
of 4 units

Consumer
Surplus

Total Cost of 4
Units

D
1

David Bryce 1996-2002

Adapted from Baye 2002

Quantity