SHIFTS IN DEMAND

D D P2 P1 P0 S 0 D 0 1 2 D D S

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Elasticity Estimates for Tobacco Products in India Rijo M John

This paper(Rijo.M. John 2010) provides the first ever estimates of own- and cross-price elasticities of bidis, cigarettes and leaf tobacco in India. It was found that a doubling of a households total expenditure would have the effect of raising the average price paid for cigarettes by 11% in rural and 24% in urban India. Cigarettes, unlike other tobacco products, were found to be luxury goods in both rural and urban India with income elasticity greater than one. Estimates of own- and cross-price elasticities showed that own-price elasticity estimates of different tobacco products in India ranged between 0.4 and 0.9, with bidis and leaf tobacco having own-price elasticities close to unity. Cigarettes were the least price elastic of all. Analysis of the cross-price elasticities revealed that bidis are a complement to cigarettes. With certain assumptions, it is shown that taxes on cigarettes and bidis can be raised to many times higher than the existing rates without fear of losing tax revenue, which reveals the potential of using taxation as an effective way for both regulating tobacco use and generating tax revenue.
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Gold price

. Price and demand shows a directly proportional behavior as demand increases on an increase in price. This characteristic of gold distinguishes it from other commodities as usually the trend observed is when the price increases demand decreases, but here the feature is absolutely opposite. In India, the gold prices went up in 2007 by 20% of that in 2006 and therefore the demand in that duration increased by 5% showing the direct affect on each other.

According to usual consumer behavior, when the price increases, people tend to consume less. This holds true even in case of staple products which are essential to them. But for gold, when the price increases, people think of this as an opportunity of better returns and therefore a better option for investment. Gold prices usually show a fall when the financial market shows some buoyancy or when the mining activities resume their productions. Comparing the nominal and the previous price, the former is always higher than the latter therefore making gold a profitable project for safe investment.
Despite the fact that in the past many years gold was never thought to be a good area of investment compared to the real estates and share market, but now gold has established itself as the best return on investment criteria. People nowadays invest a major part of their income in gold in India.
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RELATIONSHIP BETWEEN AR, MR AND ELASTICITY

TOTAL REVENUE ( TR)= PRICE(P) X QUANTITY (Q)

AVERAGE REVENUE (AR) =TOTAL REVENUE PER UNIT AR= R/Q =PQ/Q MARGINAL REVENUE ( MR) = ADDITIONAL REVENUE WHICH A SELLER OBTAINS BY SELLING AN ADDITIONAL UNIT MR= R Q R = P.Q ..eq1 Differentiating both sides of the equation we get MR= R Q P+ Q
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=P Q Q X P Q

+Q P ...eq2 Q

P(1+ Q X P) P Q ELASTICITY OF DEMAND =/ep/= P Q . Q .eq3 P

Substituting the value of ep in MR Eq WE GET.Note that elasticity Of demand has a negative sign so when modulus is removed then Minus sign appears in the formula as shown below

(Since 1/e= 1/P . - Q ) Q P MR=P( 1-1/e) MR= AR(1-1/e)

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RELATIONSHIP BETWEEN ep , MR ,P and TR

E=1,MR=0,

Ep>1,MR>0, Ep<1,MR<0

TR is max and it remains same when p rises TR falls as price rises TR Rises when p rises

MR=P(1-1/E)

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Fuel price Hike may cut demand. Hike in price of petrol and diesel may cause a definite slowdown in demand for these items With the prices of petrol and diesel soaring to a new high demand for used fuel efficient cars have gone up and bigger and less efficient cars like Honda Civic, Hyundai Elantra and Ford Fiesta will bring down their prices. At present food accounts for nearly a third of Asian personal expenditure so despite rise in food prices consumption will continue to grow at the rate of 3.7% matching the supply growth of 3.7%
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Jet,Spice to cut flight routes aimed at pruning losses following hike in ATF Rates by oil companies.Record fuel costs will plunge the airline industry back into loss t and cause a rise in prices However the rise in costs of fuel cannot be entirely borne by the price sensitive Customer and has to be absorbed into their own costs

Glaxo Smithklines Consumer Healthcares offering Womens Horlicks was the best--ever launch because of its unique product design And advertising
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= = =

Q1 Q0 P1 P0 Q1 Q0 P1 P0

X X X

(P0 +P1)/2 (Q0 + Q1)/2 P0 +P1 Q0 + Q1 P0 +P1 Q0 + Q1

Q P

MOVEMENT FROM R TO S (P1 P0) is -ve

MOVEMENT FROM S TOR

is -ve

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1)

COMPUTE ARC ELASTICITY BETWEEN C & D

MONTHLY DEMAND SCHEDULE FOR RICE PRICE Qd A 10 30 B 11 25 C 12 21 D 13 18

RICE DEMANDED P1 = 12 q 1 = 21 P2 = 13 q 2 = 18

P =1 Q = -3 epD = -3 X (12 +13) = -3 X 25 SINCE (Q X P1 +P2) 1 (21+18) 39 (P Q1 + Q2) = -1.92

epD = -1.92

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10

P A O

LOWER SEGMENT
UPPER SEGMENT R O

Let us consider a demand curve AB and measure its elasticity at point R. AB TANGENT TO THE DEMAND CURVE P = Slope of AB = - OA

Q
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OB
11

 ep

Q = - 0B P 0A = Q P = P Q

- 0B 0A

x RN --(1) RM

All triangles AOB, AMR & NRB are all similar 0B = NB 0A RN ( SUBSTITUTING IN EQ (1) ep = - NB * RN RN RM = -NB RM ep = -RB ( NB/RM = RB/AR) AR

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12

Unitary Elastic % Q=%P Relatively Elastic % Q > % P Perfectly Elastic % P = 0 Relatively Inelastic % Q<% P Perfectly Inelastic % Q = 0
P
p

e e e e e

= > = < =

1 1 1 0

0
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e >1 e =1
p p

R ep<1

e
B

=0
13

THE DEMAND FOR MEAT IS GIVEN AS FOLLOWS Qm = 5850 6 Pm + 2Pc + 0.15

= Pm = Pc = INCOME OF RAVI = RS. 8000 PRICE OF MEAT = RS. 125/Kg PRICE OF CHICKEN = RS. 70/Kg

CALCULATE (A) INCOME ELASTICITY

(B) CROSS PRICE ELASTICITY (C) PRICE ELASTICITY

SOLUTION

= Qm x

Qm

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14

Differentiating the demand function w.r.t. we have

Qm

0.15

FROM THE DEMAND FUNCTION WE HAVE Qm = 5850 (6 x125) + (2 x 70) + 0.15 x 8000 = 5850 750 + 140 + 1200 = 6440

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15

SUBSTITUTING THE VALUES OF & Qm we have

Qm

ey

= 0.15 x 8000 =
6440

0.186

= 0.186

CROSS

PRICE Pc

ELASTICITY

ec =

Qm

Pc Qm Differentiating Qm w.r.t Pc we have Qm Pc = 2 70 6440 = 0.02

ec

2 x

Meat & Chicken are Substitutes

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16

PRICE ELASTICITY

ep =

Qm Pm X Pm Qm

Differentiating m w.r.f. to Pm we have Qm = Pm -6

ep = -6 x 125 = -0.11 6440

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17

DIFFERENCE IN SLOPE AND ELASTICITY Same slope OA/OB=OC/OD BR/RA> DS/SC C A P R S A Same elasticity but Different slope

C Q

DIAGRAMATIC FORM

When P

E<1. gain >loss so TR

GAIN IN REVENUE

E>1 loss>gain so TR E=1 loss=gain so TR is same

P2

. .

P1 LOSS IN REVENUE

Q1 Q2

PERFECTLY ELASTIC AND PERFECTLY INELASTIC DEMAND CURVES A P1 P2 P3

E
C

Q1

Q2

Q3

DETERMINANTS OF PRICE ELASTICITY CLOSENESS OF SUBSTITUTES PROPORTION OF INCOME SPENT ON GOOD TIME ELAPSED SINCE PRICE CHANGE NATURE OF GOOD DETERMINANTS OF INCOME ELASTICITY NATURE OF THE NEED THE GOOD COVERS INITIAL INCOME LEVEL OF A COUNTRY TIME PERIOD DETERMINANTS OF CROSS ELASTICITY NATURE OF THE GOOD RELATIVE TO THEIR USES

PROBLEMS FOR PRACTICE

A FIRM PRODUCING PRODUCT X FACES THE FOLLOWING DEMAND FUNCTION

Qx =12000 5000 Px + 5I + 500 Pc Px =Price of product I = Income per capita Pc = Price of competing good 1) Determine what effect a price increase will have on total revenues 2) If per capita income rises by 5% next year what is the effect on sales of Good X 3) Assess the probable impact of competing firm changing its prices
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FIND OUT INCOME ELASTICITY OF DEMAND BETWEEN SUCCESSIVE RANKS

INCOME/ MONTH QTY/ MONTH 400 10 600 20 800 30 1000 35 1200 38 1400 39 1600 50 1800 25

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23

GIVEN THE FOLLOWING DATA Px 2.50 2.75 2.75 3.00 Py 3.00 3.25 3.50 3.50 Qx 600 650 700 650

*Can we compute price elasticity of demand between a price of 2.50 and 2.75? Why orWhy not? *What is the cross elasticity of demand of X w.r.t Y between price of 3.25 and 3.50 *What is its own price elasticity of demand for X between a price of 2.75 and 3.00? *Is X a normal good *Are X& Y substitutes or complements
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Do

s1

APPLICATIONS
so

s1 so

Es=ed s1 so q1 q2 Do

Ed=inf po s1 so q1 do q2 do

s1

P1 po s1

so

Ed=0 q2

so
q1

s0 d0 Es=infinity Es=0 d p1 po d0

si
s0

q1 q2

solutions If good X &Y are related goods we cannot compute Ep between The range of Rs 2.5 and 2.75 as the 50 change could be due To a change in price of Y from 3.00 to 3.25 2) Here the price of Y changes and that of X is constant so cross Elasticity can be computed as dQx/Qx/dpy/py =50/0.25 X 6.75/1350 = 1.00 (Substitutes) 3)Price elasticity of X for the range 2.75 and 3 can be computed As price of Y remains unchanged dQ /Q X P/dP -50/1350X 5.75/0.25 =-0.85 4)Data is insufficient 5) X&Y are substitutes

Demand function is Qx= 12000 5000Px +5I +500Pc

Substituting the values of Pc , I and Px we get

Qx =12000-5000(5) +5(10000) +500(6) = 40000

Ep =dQ/dp.P/Q = -5000 X 5/40000 =-0.625

Ei =dQ/dp .I/Q = 5 X 10000/40000 =1.25 Ec = dQ/dpc .Pc /Qx = 500 X 6/40000 =0.075 (substitutes)

EXPERIMENT 1 Measure of total satisfaction (utils) Number of Pizzas consumed 1 2 3 4 5 6

Consumer 1

Consumer 2

CONSUMER BEHAVIOUR AND ANALYSIS UTILITY : EXTENT OF OF SATISFACTION OBTAINED FROM THE
CONSUMPTION OF GOODS AND SERVICES PREFERRED BY CONSUMERS

APPROACHES
CARDINALIST APPROACH : Utility

can be measured in subjective terms or it is quantifiable.

ORDINAL APPROACH : Utility

cannot be measured but only ranked in Order of preference.

CARDINAL APPROACH Law of Diminishing marginal Utility

TOTAL UTILITY : Total satisfaction enjoyed from the

consumption of the good.

MARGINAL UTILITY : Rate of change in total utility per unit

charge in the quantity of the good consumed. Change in total Utility 1 unit change in Quantity Consumed

LAW OF DIMINISHING MARGINAL UTILITY

Marginal Utility of any good tends to decline as we consume more Units of it over a definite period of time. The diagramatic representation is as follows.

Law of Diminishing Marginal Utility

Total Utility 40 30 20 10 0 0 1 2 3 4 5 6 7 8 Total Utility

Pints of Beer 0 1 2 3 4 5 6 7

TU 0 10 18 24 28 30 30 29

MU 10 8 6 4 2 0 -1

Utility Economists use the term utility to describe the satisfaction or enjoyment derived from the consumption of a good or service. If we assume that consumers act rationally, this means they will choose between different goods and services so as to maximize total satisfaction or total utility.

Consumers will take into consideration

How much satisfaction they get from buying and then consuming an extra unit of a good or service The price that they have to pay to make this purchase The satisfaction derived from consuming alternative products The prices of alternatives goods and services

Experiment 2 Consumers go shopping with Rs 2500 in hand each Measure of satisfaction (UTILS) Items Available Price Cons 1 Cons 2 Branded Jeans Herbal cosmetics Pizzas Fancy Watches Hamburgers AJewellery 1000 200 150 500 100 500

EQUILIBRIUM CONDITION LAW OF EQUI MARGINAL UTILITY Going by the assumption of rationality consumer attains equilibrium Only when he uses that bundle of goods which gives him the highest level of satisfaction Suppose a consumer spends his income in purchasing 3 goods X1, X2, X3 with respective prices of P1, P2 &P3 the consumer will allocate his income between the three goods in such a way that the Marginal utility per Rs he spends on every good is equalised and his total utility is maximised. Eg if here are n number of goods MU/P1=MU/P2=MU/P3..=MUn/Pn=Mum

If MU1/P1>MU2/P2 then the rational consumer will consume more of X1 till MUI/P1=MU2/P2

Assumptions The principle of equi-marginal utility is based on the following assumptions: (a) The wants of a consumer remain unchanged. (b) He has a fixed income.Marginal utility of money is constant (c) The prices of all goods are given and known to a consumer. (d) He is one of the many buyers in the sense that he is powerless to alter the market price.

(e) He can spend his income in small amounts.

(f) He acts rationally in the sense that he want maximum satisfaction (g) Utility is measured cardinally. This means that utility, or use of a good, can be expressed in terms of units or utils. This utility is not only comparable but also quantifiable.

CRITICISMS OF UTILITY THEORY Some economists claim that utility cannot be measured objectively. There are also doubts about the assumption of rational behaviour among consumers - particularly in a world where consumers cannot expect to have all the information available on the products available in a market. The importance of consumer feedback In standard price theory, the preferences of consumers are taken as fixed - yet we observe that consumer's behaviour in a market is often influenced by their interaction with other consumers and this then affects demand. A good example of this is the behaviour of consumers who attend showings of a new film to a cinema. Their reaction to a film will often determine how many other people choose to pay to watch the same film. Consumer feedback may be more significant than any amount of hype and advertising before a film is released . Another good example is the feedback of consumers who visit a local restaurant or feedback from people who have stayed at a particular holiday resort. Their experiences may exert a significant influence on the preferences and choices of other consumers. It is little wonder that many successful firms trace some of their success at their willingness and ability to respond pro-actively to consumer feedback.

Derivation of the demand curve

Eqiulibrium condition of the consumer is given as MU =MUmP1 If P1 falls it automatically implies that MU should fall for equilibrium to be restored Furthermore it is evident that MU can decrease only if Quantity demanded increases

p1
mu1 p2 p3

mu2
mu3

q1

q2

q3

q1

q2

q3

Therefore when price of good falls consumer will buy more of the good To equate marginal utility to lower price. Hence the inverse relationship Between price & quantity