Law of Demand

H ldi all other thi Holding ll th things constant ( t i t t (ceteris paribus), there is an inverse relationship between th price of a normal good and b t the i f l d d the quantity of the normal good demanded per ti d d d time period i d
Substitution Effect Income Effect

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 1

Components of Demand: p The Substitution Effect

A Assuming th t real i i that l income i constant: is t t
If the relative price of a good rises, consumers will t t substitute away ill try to b tit t the good. Less will be purchased If the relative price of a good falls falls, consumers will try to substitute away other goods More will be purchased goods. then from f then from

The substitution effect is consistent with the law of demand

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 2

Components of Demand: The Income Eff t Th I Effect The real value of income is inversely related to the prices of goods A change in the real value of income:
will have a direct effect on quantity demanded if a good is normal will have an inverse effect on quantity demanded if a good is inferior

The income effect is consistent with the law of demand only if a good is normal
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 3

Individual Consumers Demand QdX = f(PX, I, PY, T) QdX = quantity demanded of commodity X by an individual per time period PX = price per unit of commodity X i it f dit I = consumers income co su e s co e PY = price of related (substitute or complementary) commodity l t ) dit T = tastes of the consumer
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 4

QdX = f(PX, I PY, T) I, QdX/PX < 0 if a good is normal QdX/I > 0 if a good is normal QdX/I < 0 if a good is inferior QdX/PY > 0 if X and Y are substitutes QdX/PY < 0 if X and Y are complements

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 5

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 6

The image cannot be display ed. Your computer may not hav e enough memory to open the image, or the image may hav e been corrupted. Restart y our computer, and then open the file again. If the red x still appears, y ou may hav e to delete the image and then insert it again.

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 7

Market Demand Curve

Horizontal summation of demand curves of individual consumers Market demand is also influenced by
Bandwagon Effect
when people demand a commodity because others are purchasing it (e g Tatas Nano Car) (e.g., Tata s

Snob (Veblen) Effect

arises when some consumers want to be different from other consumers by demanding less of a commodity of mass consumption and demanding more of expensive products
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 8

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 9

Market Demand Function QDX = f(PX, N, I, PY, T) QDX = quantity demanded of commodity X PX = price per unit of commodity X N = number of consumers on the market I = consumer i income PY = price o related (subs u e o p ce of e a ed (substitute or complementary) commodity T = consumer t t tastes
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 10

Demand Curve Faced by a Firm Depends on Market St D d M k t Structure t

Imperfectly competitive markets such as Monopoly, Monopolistic Competition and Oligopoly
Firm is a price maker Fi demand curve has a negative slope Firms d d h ti l

Perfectly competitive market

Firm is a price taker Firms demand curve is horizontal
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 11

Demand Curve Faced by a Firm y Depends on the Type of Product

Durable Goods such as machines, refrigerators, etc. washing

Demand is volatile or unstable as compared to demand for non-durable goods

Producers Goods that used in the production of other goods (e.g., steel, cement, etc.)
Demand is derived from demand for final goods d
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 12

Linear Demand Function

QX = a0 + a1PX + a2N + a3I + a4PY + a5T PX
Slope: QX/PX = a1 Intercept: a0 + a2N + a3I + a4PY + a5T

QX
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 13

Linear Demand Function Example Part 1

Demand Function for Good X QX = 160 - 10PX + 2N + 0 5I + 2PY + T 0.5I Demand Curve for Good X Given N = 58, I = 36, PY = 12, T = 112 QX = 430 - 10PX
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 14

Linear Demand Function Example Part 2

Inverse Demand Curve for Good X PX = 43 0.1QX Total and Marginal Revenue Functions TRX = 43QX 0.1QX2 MRX = 43 0.2QX
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 15

Price Elasticity of Demand

Point D fi iti P i t Definition:
Q / Q Q P EP = = P / P P Q
P EP = a1 Q

Linear Function:

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 16

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 17

Price Elasticity of Demand

Arc Definition: A D fi iti
Q2 Q1 P2 + P 1 EP = P2 P Q2 + Q1 1

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 18

Marginal Revenue and Price Elasticity of Demand

1 MR = P 1 + EP

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 19

Marginal Revenue and Price Elasticity of Demand

PX
EP > 1 EP = 1
EP < 1

MRX
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

QX
Slide 20

Copyright 2007 by Oxford University Press, Inc.

Marginal Revenue, Total g , Revenue, and Price Elasticity

TR MR>0
EP > 1
MR<0

EP < 1

EP = 1 MR=0
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

QX
Copyright 2007 by Oxford University Press, Inc.
Slide 21

Determinants of Price Elasticity of Demand

The demand for a commodity will be more price elastic if: It has more close substitutes More time is available for buyers to y adjust to a price change

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 22

Determinants o Price ete a ts of ce Elasticity of Demand

The demand for a commodity will be less price elastic if: It has fewer substitutes Less time is available for buyers to y adjust to a price change

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 23

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 24

Income Elasticity of Demand

Point D fi iti P i t Definition:

Q / Q Q I EI = = I / I I Q
I EI = a3 Q

Linear Function:

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 25

Income Elasticity of Demand

Q2 Q1 I 2 + I1 EI = I 2 I1 Q2 + Q1

Arc Definition: A D fi iti Normal Good:

EI > 0

Inferior Good:
EI < 0

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 26

The image cannot be display ed. Your computer may not hav e enough memory to open the image, or the image may hav e been corrupted. Restart y our computer, and then open the file again. If the red x still appears, y ou may hav e to delete the image and then insert it again.

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 27

Cross-Price Cross Price Elasticity of Demand

QX / QX QX PY = = PY / PY PY QX
PY = a4 QX

Point D fi iti P i t Definition:

E XY

Linear Function:

E XY

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 28

Cross-Price Cross Price Elasticity of Demand

QX 2 QX 1 PY 2 + PY 1 = PY 2 PY 1 QX 2 + QX 1

Arc Definition: A D fi iti Substitutes:

E XY > 0

E XY

Complements:
E XY < 0

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 29

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 30

Example: Using Elasticities in Managerial Decision Making

A firm with the demand function defined below expects a 5% increase in income (M) during the coming year. If the firm cannot change its rate of production, what price should it charge?

Demand: Q = 3P + 100M
P = Current Real Price = 1,000 M = Current Income = 40
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 31

Solution
Q = Current rate of production = 1,000 Elasticities
EP = Price-elasticity = - 3(1,000/1,000) = - 3 EI = Income-elasticity = 100(40/1,000) = 4

Price Change due to Increase in M by 5% g y %Q = - 3%P + 4%I

0 = -3%P+ (4)(5) ( )( ) %P = 20/3 = 6.67% ( )( ) P = (1 + 0.0667)(1,000) = 1,066.67
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 32

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 33

 International Convergence of Tastes (e.g., CocaCola, McDonald, Adidas, etc.) Cola McDonald Adidas etc )
Globalization of Markets (Levitt, 1983 found that consumers from New York to Frankfurt to Tokyo want similar products, th th requirement f more i il d t thus the i t for standardized products and pricing around the world) Influence of International Preferences on Market Demand

Other Factors Related to Demand Theory

Growth of Electronic Commerce (B2B & B2C marketing through Internet)

Reduction in Cost of Sales Reformulating Supply Chains and Logistics g pp y g Redefining Customer Relationship Management
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 34

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2007 by Oxford University Press, Inc.

Slide 35

Price Elasticity and Tax Burden

When the demand curve is perfectly elastic and the supply curve is elastic, the entire tax burden is borne by sellers When the demand curve is perfectly inelastic and the supply curve is elastic, the entire tax burden is borne by buyers When the supply curve is perfectly elastic and the demand curve is elastic, the entire tax burden is borne by buyers When the supply curve is perfectly inelastic and the demand curve is elastic, the entire tax burden is borne by sellers y
7/6/2010

Copyright 2007 by Oxford University Press, Inc.

Price Elasticity and Tax Burden

When the demand curve for a commodity is more elastic (epd > 1) as compared to the supply curve, the less is the tax burden for buyers or the more is the tax burden for sellers When the demand curve for a commodity is less elastic (epd < 1) as compared to the supply curve, the more is the tax b d t burden f b for buyers or th l the less i th t is the tax b d burden f for sellers When the supply curve for a commodity is more elastic (eps > 1) as compared to the demand curve, the less is the tax burden for sellers or the more is the tax burden for y buyers When the supply curve for a commodity is less elastic (eps < 1) as compared to the demand curve, the more is the tax burden for sellers or the less is the tax burden for buyers
7/6/2010

Copyright 2007 by Oxford University Press, Inc.