DEMAND ANALYSIS-II

ELASTICITY OF
DEMAND
Slope of the Demand curve

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 income
PY =
price of related (substitute or
complementary) commodity
T=
consumer tastes

Demand Curve Faced by a Firm

Depends on Market Structure
Market demand curve
Imperfect competition
Firms demand curve has a negative slope
Monopoly - same as market demand
Oligopoly
Monopolistic Competition
Perfect Competition
Firm is a price taker
Firms demand curve is horizontal

Demand Curve Faced by a Firm Depends on the

Type of Product
Durable Goods
Provide a stream of services over time
Demand is volatile
Nondurable Goods and Services
Producers Goods
Used in the production of other goods
Demand is derived from demand for final goods or services

Linear Demand Function

QX = a0 + a1PX + a2N + a3I + a4PY + a5T
PX

Intercept:
a0 + a2N + a3I + a4PY + a5T

Slope:
QX/PX = a1

QX

Linear Demand Function Example Part 1

Demand Function for Good X
QX = 160 - 10PX + 2N + 0.5I + 2PY + T
Demand Curve for Good X
Given N = 58, I = 36, PY = 12, T = 112
Q = 430 - 10P

Linear Demand Function Example Part 2

Inverse Demand Curve

P = 43 0.1Q
Total and Marginal Revenue Functions
TR = 43Q 0.1Q2
MR = 43 0.2Q

Price Elasticity of Demand

Point Definition

Q / Q Q P
EP

P / P P Q

Price Elasticity of Demand

Arc Definition

Q2 Q1 P2 P1
EP

P2 P1 Q2 Q1

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

MRX

QX

Determinants of Price Elasticity of Demand

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

Determinants of Price Elasticity of Demand

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

Income Elasticity of Demand

Point Definition

Q / Q Q I
EI

I / I
I Q

Income Elasticity of Demand

Arc Definition

Q2 Q1 I 2 I1
EI

I 2 I1 Q2 Q1

Normal Good

Inferior Good

EI 0

EI 0

Cross-Price Elasticity of Demand

Point Definition

E XY

QX / QX QX PY

PY / PY
PY QX

Cross-Price Elasticity of Demand

Arc Definition
Substitutes
E XY 0

E XY

QX 2 QX 1 PY 2 PY 1

PY 2 PY 1 QX 2 QX 1

Complements
E XY 0

QUESTIONS?