In this video, learn about the structure of demand curves.
- [Instructor] Demand is one of the most critical concepts that business people face. They're two common types of demand curves that businesses often see. Linear demand curves and power demand curves. Both linear demand curves and power demand curves give us a sense for the relationship between price and the number of units we can except to sell. But, that specific relationship differs between the two. In the case of linear demand curves, demand, the number of units sold at a given price falls linearly as we increase price and it's defined by the equation we see here.
Demand is equal to, a minus b times price. Here a is our base demand regardless of price and b is the demand that depends on price. We can think about this with say, gasoline. If gasoline prices were $10 per gallon, there's some amount that you'd still have to buy no matter what. For example, the gas you need to get to work, perhaps. On the other hand, there's also some other gas that you probably use today, because gas is less that $10 a gallon which you wouldn't otherwise use.
Maybe trips for vacation or leisure or things like that. In a power demand curve, price elasticity has a more dramatic impact on demand. In particular, here demand is equal to a times price raised to the factor of b. And again, a is our base demand level and b is the level of demand that demands on price. So as we see here, both a and b have a lot more impact and effective price is much more dramatic than in a linear demand curve.
So when we face power demand, we have to be significantly more careful about where we set our price than when we face a linear demand curve. Alright, now you might wonder, what is it that is special about my business that tells me whether I have a linear demand curve or a power demand curve? Well the truth of the matter is that we can't tell that without looking at data. This is where business intelligence and data analytics become particularly important. We really need to be able to identify what we call price elasticity.
Price elasticity tells us which curve is appropriate. If we have a linear demand curve, then our product's price elasticity changes as price changes. If we have a power demand curve, then our price elasticity remains constant as price changes. That price elasticity is really the representation of how much we expect our sales to change, as we change price.
- Break down how price affects both supply and demand.
- Explain how to use linear interpolation to make optimal pricing decisions.
- Identify different types of price discrimination.
- Give examples of inelastic pricing.
- Predict the effect higher margins for your products would have on your competitors.
- Compare the value of a unit of price to a unit of volume.