Guide to COST-BENEFIT ANALYSIS of investment projects - Ramiri

ANNEX ADEMAND ANALYSISDemand forecasting is an important step in the feasibility study of a project, as it allows us to assess how much of agood or a service will be requested in the future, as well as the revenues that can be expected from the sale of thatgood or service.Theoretical backgroundAccording to standard microeconomics each consumer has a utility function U, which is an increasing function ofthe quantity of each good consumed.The behaviour of the consumer can be symbolized by the following constrained maximizationMax U(x 1 ,x 2 …x n )withΣp i x i ≤ rWhere r is the budget (disposable income) of the consumer.So it is assumed that the consumer will try to maximise her or his utility under the constraint that expenditure cannotexceed income. The solution of this problem leads to the demand curve.The demand curve is defined as the relationshipbetween the price of the good and the amount or Figure A.1 Demand and Supply Curvesquantity the consumer is willing and able to purchasein a specified time period.PSThe consumers’ willingness and ability to purchasethe good is influenced not only by the price of thegood but also by income, the prices of related goods,and tastes.DIn the diagram, D is the demand curve, P is the price,QQ is the quantity (number of product units), and S isthe supply curve. As the price P on the vertical axisdecreases, so the quantity demanded Q increases.Forecasting demand requires estimating the changes in the conditions that determine the equilibrium betweendemand and supply (special models are required for rationed markets). Such conditions include: consumer income,tastes, supply costs, additional demand induced by the new project, etc. For instance, when the price of the goodchanges and other demand determinants are constant, the outcome is given by a new equilibrium on the samedemand curve. Instead, if a non-price determinant changes in such a way as to increase demand, this is a ‘shift’ orsimply ‘change’ in the demand curve, as shown in the following diagram.PSPSS’D’D’DQDQINCOME EFFECTDECREASE IN PRODUCTIONCOSTS200