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Chapter 2

Demand

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Demand
Demand is---
Willingness

Ability to pay

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Demand
Demand is a function of:
- own price
- Prices of related commodities
- income
- tastes and preferences
- others

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Law of Demand
- Ceteris Paribus conditions
- “ all other factors remaining constant”

- inverse relationship between own price and quantity demanded

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Why negative slope?
- Substitution effect of a price change

- income effect of a price change

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Exceptions
- negative income effect greater than substitution effect

Giffen good

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Shifts in Demand
When ceteris paribus assumption is relaxed

When income/ tastes change


or

simply when ‘time’ changes’

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Shifts in and movements along a
Demand Curve
Effect on demand of changes in its own price results in movement along
the demand curve.

Effect on demand of changes in other factors results in shifts in demand


curve

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Market Demand
Horizontal summation of individual demand curves

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Elasticity
Price Elasticity: Proportionate change in quantity demanded due to a
proportionate change in price
- ∆Qx/ ∆Px * Px/Qx
- negative for normal goods
- negative sign is ignored while making comparisons among normal
goods

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Price Elasticity
Pe Greater than1 (ignoring – sign): Elastic
Pe Equal to 1 (ignoring – sign) : Unit Elastic
Pe Less than 1 ( ignoring – sign): Inelastic
Price Elasticity and Expenditure:
- Pe less than 1 a fall in price lower exp
- Pe equal to 1 a fall in price exp constant
- Pe greater than 1 a fall in price higher exp

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Price elasticity
Special cases:
Infinitely elastic

Zero elasticity

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Price elasticity
Along a linear demand curve:

P
Pe > 1

Pe < 1

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Total, Average, and Marginal
magnitudes
Q P TR MR Q P TR MR
(=AR)
0 10 0 - 6 4 24 -1
1 9 9 9 7 3 21 -3
2 8 16 7 8 2 16 -5
3 7 21 5 9 1 9 -7
4 6 24 3
5 5 25 1

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Derivation
Q=10 – P
P = 10 – Q
TR = P.Q = (10 - Q).Q = 10Q-Q2

MR= dTR/dQ = 10 – 2Q

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Price elasticity
Price elasticity and MR:
TR = P (Q) *Q
MR = dTR/dQ = P + Q dP/dQ
= P(1+ (Q/P * dP/dQ)
= P (1 + 1/Pe)
With Pe being –ve, it becomes
P ( 1- 1/Pe) (and Pe is without the –ve sign)

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Marginal Revenue and Price
Elasticity of Demand

 1 
MR  P 1  
 EP 
Marginal Revenue and Price
Elasticity of Demand
PX
EP  1
EP  1

EP  1

QX
MRX
Marginal Revenue, Total Revenue, and
Price Elasticity

TR MR>0 MR<0
EP  1 EP  1

QX
EP  1 MR=0
Price elasticity
Price elasticity and AR:
Since Ar =P,
We have MR = AR (1 – 1/Pe)
MR = AR – AR/ Pe
…….
……
Pe = AR / (AR – MR)

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Income Elasticity
Income Elasticity
∆Qx/∆I * I/Qx

Could be negative or positive:


Negative for Inferior goods
Positive for Superior goods

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Cross Price Elasticity
Cross Price Elasticity:
∆Qx/∆Py * Py/Qx

Could be negative or positive


- Negative for complements
- Positive for substitutes

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