Law of Demand

Law of Demand - Transcript

Law of Demand Law of Demand
Holding all other things constant ceteris paribus there is an inverse relationship between the price of a normal good and the quantity of the normal good demanded per time period
Substitution Effect Income Effect

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Slide 1

Components of Demand The Substitution Effect
Assuming that real income is constant
If the relative price of a good rises consumers will try to substitute away the good Less will be purchased If the relative price of a good falls consumers will try to substitute away other goods More will be purchased then from then from

The substitution effect is consistent with the law of demand
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Slide 2

Components of Demand The Income Effect Eff 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
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Slide 3

Individual Consumer s Demand QdX f PX I PY T QdX quantity demanded of commodity X demanded of commodity by an individual per time period PX price per unit of commodity X I consumer s income PY price of related substitute or complementary commodity T tastes of the consumer
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Slide 4

Qd f P QdX f PX I PY T T QdX PX 0 if a good is normal QdX I 0 if a good is normal if 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

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Slide 5

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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

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Slide 7

Market Demand Curve 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 Tata s Nano Car

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
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Slide 8

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Slide 9

Market Demand Function QDX f PX N I PY T QDX quantity demanded of commodity X demanded of commodity PX price per unit of commodity X N number of consumers on the market I consumer income PY price of related substitute or subs complementary commodity T consumer tastes
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Slide 10

Demand Curve Faced by a Firm Depends on Market Structure St
Imperfectly competitive markets such as competitive markets such as Monopoly Monopolistic Competition and Oligopoly Oligopoly
Firm is a price maker Firm s demand curve has a negative slope

Perfectly competitive market
Firm is a price taker Firm s demand curve is horizontal
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Slide 11

Demand Curve Faced by a Firm 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
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Slide 12

Linear Demand Function Linear Demand Function
QX a0 a1PX a2N a3I a4PY a5T PX
Slope QX PX a1 Intercept a0 a2N a3I a4PY a5T

QX
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Slide 13

Linear Demand Function Example Part 1
Demand Function for Good X QX 160 10PX 2N 0 5I 2PY T 160 10P 2N 2P Demand Curve for Good X Curve for Good Given N 58 I 36 PY 12 T 112 QX 430 10PX
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Slide 14

Linear Demand Function Linear Demand Function Example Part 2
Inverse Demand Curve for Good X PX 43 0 1QX Total and Marginal Revenue Functions and Marginal Revenue Functions TRX 43QX 0 1QX2 MRX 43 0 2QX
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Slide 15

Price Elasticity of Demand
Point Definition
Q Q Q P EP P P P Q
P EP a1 Q

Linear Function

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Slide 16

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Slide 17

Price Elasticity of Demand
Arc Definition
Q2 Q1 P2 P 1 EP P2 P Q2 Q1 1

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Slide 18

Marginal Revenue and Price Marginal Revenue and Price Elasticity of Demand
1 MR P 1 EP

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Slide 19

Marginal Revenue and Price Marginal Revenue and Price Elasticity of Demand
PX
EP 1 EP 1
EP 1

MRX
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QX
Slide 20

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Marginal Revenue Total Revenue and Price Elasticity
TR MR 0
EP 1
MR 0

EP 1

EP 1 MR 0
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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 adjust to a price change

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Slide 22

Determinants of Price ete 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 adjust to a price change

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Slide 23

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Slide 24

Income Elasticity of Demand Income Elasticity of Demand

Point Definition

Q Q Q I EI I I I Q
I EI a3 Q

Linear Function

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Slide 25

Income Elasticity of Demand Income Elasticity of Demand
Q2 Q1 I 2 I1 EI I 2 I1 Q2 Q1

Arc Definition Normal Good
EI 0

Inferior Good
EI 0

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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

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Slide 27

Cross Cross Price Elasticity of Demand Elasticity of Demand
QX QX QX PY PY PY PY QX
PY a4 QX

Point Definition

E XY

Linear Function

E XY

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Slide 28

Cross Cross Price Elasticity of Demand Elasticity of Demand
QX 2 QX 1 PY 2 PY 1 PY 2 PY 1 QX 2 QX 1

Arc Definition Substitutes
E XY 0

E XY

Complements
E XY 0

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Slide 29

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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
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Slide 31

Solution 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 Q 3 P 4 I
0 3 P 4 5 P 20 3 6 67 P 1 0 0667 1 000 1 066 67
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Slide 32

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Slide 33

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

Other Factors Related to Demand Theory Demand Theory

Growth of Electronic Commerce B2B B2C marketing through Internet marketing through Internet
Reduction in Cost of Sales Reformulating Supply Chains and Logistics Redefining Customer Relationship Management
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Slide 34

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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
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 burden for buyers or the less is the tax burden 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 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