Markets have to be researched because each one is different and shaped by different forces (economic, political, demographic, international and social). It is not possible to generalize about customers or to take short cuts by using information from one market to take decisions in another. Since markets change, and there are even changes in the same market, information has to be updated as circumstances change.
The main variable influencing market demand is the price of the goods or service, but there are other relevant factors, such as: consumer tastes and preferences, consumer income, price of related items, consumer expectations. A knowledge of how changes in these variables can modify the quantities of goods sold is very important for the enterprise and the producer, and an essential aspect of demand analysis. The expression used to describe how quantity demanded responds to a change in one demand variable is Elasticity of Demand. Price elasticity shows the sensitivity of product demand to price changes. When elasticity is less than 1, demand is inelastic. When elasticity is greater than 1, demand is elastic.
One strategic application of these concepts will be described: the decision to mechanize or completely automate a process depends partly on the elasticity of demand for the product concerned. Assuming the main reason for mechanization is to reduce production costs (and not, for example, to avoid labour disputes or improve safety), it is logical that some of the savings be passed on to consumers in order to increase demand, which will in turn allow the maximum use of expensive equipment. If demand is elastic, this policy would be the obvious choice. An inelastic demand would make this policy less attractive, as any increase in volume resulting from reduction in price, will be relatively small.
Similarly, the income elasticity of demand measures the relative effect of a change in income on quantity demanded. Goods with positive elasticity are "normal", while those with negative income elasticity are "inferior". Another measure is cross-elasticity; it shows the sensitivity of the demand for one product relative to price changes in another product. When the cross-elasticity coefficient is positive, the two goods are substitutes; when the coefficient is negative, a complementary relationship is indicated. The closer the coefficient is to zero, the more independent are the two items.
The concept of elasticity can be also applied to supply. For example, an analysis of labour supply in Thailand (Panayotou, 1986) shows that elasticity of labour in fisheries with respect to total salary is 0. 55, which means that a 10 % change in salary would bring a 5.5 % shift in supply of labour for fishing. However, the same change in total income of fishermen, workers, etc., would affect the fisheries labour supply by less than 1 %.
It is noted that the methods of projection for market demand curves are generally based on extrapolation of historical data and a knowledge of the income-demand function, using statistical techniques for forecasting and time-series information.
The mathematical expression which simultaneously defines the influence of, and changes in, income and price, takes the special form of a Cobb-Douglas function
where Q represents quantity demanded, P is the price index, 1 income per
caput, 
p the price elasticity
coefficient and c, the income elasticity coefficient. A useful property of this function
is to be converted in a linear function if it is rewritten as:
The information provided from an estimate of future demand is invaluable for making decisions in a firm; it is a starting point to define reasonable production objectives and identify the ways and means necessary to achieve those objectives. This is not primarily an engineering function, but the achievement of sales-volume and product-price forecasts is perhaps the most important factor in determining the success of an investment.
Example A.1 Analysis of Income and Consumption. Market Outlook
Analyse the figures given in Table A. 1 for crustacean consumption in Japan.
Table A.1 Yearly Expenditure by Commodities per Household by Income Group
Shrimp, Lobster and Crab |
|||
Income Group |
Expenditure (US$) |
Quantity (100 g) |
Price (US$/100 g) |
Average income |
33.85 |
36.866 |
0.918 |
I.( -9792) |
21.38 |
25.571 |
0.836 |
II.( 9 792-12 864) |
29.18 |
32.847 |
0.888 |
III.(12864-16368) |
32.86 |
36.913 |
0.890 |
IV. (16 368-21 600) |
36.67 |
39.573 |
0.972 |
V. (21 600- ) |
49.18 |
49.427 |
0.995 |
Answer: Income cross-section in Table A. 1. shows a strong positive correlation between income and crustacean consumption. There is the obvious indication that a substantial growth in purchase and expenditure may be expected as the household income moves from group 1 to 11 and from 11 to Ill, the three of them numerically important, which suggests that rising living standards over a wide range of the Japanese populations are likely to be reflected in higher consumption of crustaceans including shrimp.
The strongly rising trends in expenditure from lower to higher income groups on this latter item suggest that the prospect for this commodity are particularly good. In order to complete the examination of the characteristics of and prospective demand for crustacean it is necessary to study the pattern of supplies, consumption on trends, price trends and distribution and marketing channels (Hotta, 1979).
Example A.2 Analysis of Wholesale Demand for Canned Sardine in Maine (USA)
Analyse the coefficient of each variable in the following equations in order to calculate the possibility of other products, such as canned sardines from the Gulf of Mexico, penetrating the US market for canned products. In the study of demand for canned sardines carried out in Maine (USA), Raizin and Regier (1986) present three equations which relate the domestic price of sardines, annual demand and price of imported sardines with the rest of the variables (all variables are expressed by their natural logarithms):
PM = - 6.09 + 0.03QM + 0.3 1P0 + 0. 142PNO + 0.064PS + 0.068PT + 0.97Y
QM = 9.10 + 0.25PM + 0.338P0 - 0.153PNO + 0.918PT - 2.03Y
PO = 3.36 - 0.369QO - 0.066PNO + 0.184PM + 0.145PS + 0.561 PT - 0.461Y
where:
PM: average price for Maine sardines paid by wholesalers (cents/1b) QM: annual per caput demand of Maine sardines by wholesalers (1b) PO: average price of imported sardines in oil, paid by wholesales (cents/1b) QO: annual per caput demand of imports in oil by wholesalers (1b) PNO: average price of imported sardines not packed in oil, paid by wholesalers (cents/1b) PS: average price of domestic salmon in oil paid by wholesalers (cents/1b) PT: average price of domestic tuna in oil paid by wholesalers (cents/1b) Y: gross income per caput
Answer: Equation 1 shows that quantity demanded has no significant effect on price but that income has a significantly positive effect. Moreover, the equation shows that prices are not determined by the demand of the wholesale market, that is, there is no significant relationship between changes in price and quantities demanded; that is because Maine producers are price-makers and thus influence the market price of sardines.
Equation 2 is an equation for demand, where income is preceded by a negative coefficient (-2.03), indicating that Maine sardines are an inferior product, where a 1 % increase in the real income of the population will cause a 2.03% reduction in demand.
Equation 3 shows the influence of external variables on the price of imported sardines. The external variables considered, at the wholesaler level, are: consumption per caput, real prices of substitute goods and real available income per caput.
In general, the reciprocal of price flexibility with respect to quantity is equal to the true value of price elasticity of demand. Price flexibility to demand (percentage change in price caused by 1 % change in demand) less than 1, implies that demand is elastic. Price flexibility to demand is (- 0.369), which implies an elasticity of demand of -2.71. This means that a 1 % increase in demand will cause a reduction of 0.369% in price. The equation also expresses the relationship of substitutes for sardine in oil. Salmon and tuna are weak substitutes for imported sardines in oil. A 1 % increase in the price of salmon will increase the price of imported sardines by 0. 145 %, while a 1 % increase in the price of tuna will increase the price of imported sardines in oil by 0.561 %. The flexibility of price to income is also negative. This indicates that a 1 % increase in income will cause a 0.461 % drop in price. A negative coefficient suggests that the product is an inferior good.
