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Name: Karina Permata Sari (29115447

)

Program: GM 2

Business Economics’ Summary

Demand Theory and Elasticity
The Demand for a Commodity
The demand for a commodity arises from the consumers' willingness and ability (i.e., from their
desire or want for the commodity backed by the income purchase the commodity backed by the
income) to purchase the commodity. Consumer demand theory showed that the quantity
demanded of a commodity is a function of, or depends on, the price of the commodity, the
consumer’s income, the price of related (i.e., complementary and substitute) commodity", and
the tastes of the consumer. In functional form, we can express this as
Qdx=f (Px, I, Py, T)
Where:
Qdx = quantity demanded of commodity X by an individual per time period (year, month, week,
day, or other unit of time)
Px = price per unit of commodity X
I = consumer income
Py = price of related (i.e., Substitute and complementary) commodities
T = consumer taste

Consumer demand theory postulates that the quantity demanded of a commodity per time period
increases with a reduction in its price, with an increase in the consumer's income, with an
increase in the price of substitute commodities and a reduction in the price of complementary
commodities, and with an increased taste for the commodity. On the other hand, the quantity
demanded of a commodity declines with the opposite changes.

From Individual to Market Demand
The market demand curve for a commodity is simply the horizontal summation of the demand
curves of all the consumers in the market. The market demand curve for a commodity shows the
various quantities of the commodity demanded in the market per time period (QDx) at various
alternative prices of the commodity, while holding everything else constant. The market demand
curve for a commodity (just as an individual's demand curve) is negatively sloped, indicating that

The Economic Concept of Elasticity Price elasticity of demand showed the measurement of sensitivity in changing the quantity demanded by the change of price. in this case. The a’s represent the coefficients to be estimated by regression analysis. we are dealing with the sensitivity of quantities bought to a change in the producer's price. Py. The demand faced by a firm will then determine the type and quantity of inputs or resources (producers’ goofs) that firm will purchase or hire in order to produce or meet the demand for the goods and services that it sells. and the number firms in the industry. That is. In different terms. we divide one percentage by the other: Coefficient of elasticity = Percent charge∈ A Percent charge∈B The Price Elasticity of Demand When we speak of the price elasticity of demand. N. the dealer's) control. Where Qx refers quantity demanded of commodity X per time period faced by the firm. that is. and Px. In most general terms. I. the price of related commodities. and it faces the industry or market demand for the commodity. this concept describes an action that is within the producer's (or. and consumers’ tastes. which is the most used technique for estimating demand. respectively. the percentage change in one variable relative to a percentage change in another. T refer. it must be pointed out that a market demand curve is simply the horizontal summation of the individual demand curves only if the consumption decisions of individual consumers are independent.price and quantity are inversely related. the firm is or represent the industry. we can define elasticity as a percentage relationship between two variables. Py. We can express the general market demand function for commodity X as: QDx = F (Px. The Demand Faced by Firm The demand for a commodity faced by a particular firm depends on the size of the market or industry demand for the commodity. Other elasticities discussed later are outside .e. N. to the price of the commodity.. I. the quantity demanded of the commodity increases when its price falls and decreases when its price rises. We can specify the linear form of the demand function faced by a firm as: Qx = a0 + a1Px + a2N + a3I + a4Py + a5T + …. If the firm is the sole producer of a commodity for which there are no good substitutes (i. the form in which the industry is organized. Thus. as before. consumers’ incomes. T) Finally. the number of consumers in the market. if the firm is a monopolist).

we arrive at the expression for the price elasticity of demand: ∆ Quantity ∆ Price ∆ Quantity ÷ = Quantity Price ∆ Price Measurement of Price Elasticity and Determinants of Elasticity The formula indicator to measure price elasticity is as follows: E p= Q2−Q1 P2−P1 ÷ (Q2+Q1 )/2 (P2+P 1)/2 Ep= Coefficient of are price elasticity Q1= Original quantity demanded Q2= New quantity demanded P1= Original Price P2= New Price Factors affecting Demand Elasticity are as follows:  Ease of Substitution  Proportion of total expenditures  Durability of Product  Possibility of postponing purchase  Possibility of repair  Used product market  Length of time period . "percentage change in quantity demanded" as: ∆ Quantity demanded Initial Quantity Demanded Where Δ (delta) signifies an absolute change. The second part of this relationship. can be written as: ∆ Quantity Price Initial Price Dividing the first expression by the second.the producer's control and may evoke other actions on the producer's part to counteract them. Demand price elasticity is defined as a percentage change in quantity demanded caused by a I percent change in price. Let us develop this concept mathematically. “percentage charge in price”. We can write the expression.

and the demand curve over the relevant range may be almost perfectly inelastic. then total revenue will increase.. quantity rises more than price has dropped. or by shifting consumption to or from this particular product (i.e.Elasticity in the Short-Run and in the Long-Run A long-run demand curve will generally be more elastic than a short-run curve. a decrease in price-will increase the quantity purchased. in percentage terms. Which of the two tendencies is stronger? Remember that elasticity is defined as the percentage change in quantity divided by the percentage change in price. As the time period lengthens. But because demand curves tend to be downward sloping. by consuming more or less of other commodities). Here "short run" is defined as an amount of time that does not permit a full adjustment by consumers to a price change. no adjustment may be possible. In the shortest of runs. The concept is as follows: TR = Price x Quantity MR = ∆ TR ∆Q Figure 1 The Relationship between Price Elasticity and Total Revenue (TR) Marginal Revenue (MR) is positive as total revenue rises (and the demand curve is elastic). If the former is larger. consumers will find ways to adjust to the price change by using substitutes (if the price has risen). The rules describing the relationship between elasticity and total revenue (TR). The Cross-Elasticity of Demand Cross-elasticity (or cross-price elasticity) deals with the impact (again. in percentage terms) on the quantity demanded of a particular product created by a price change in a related product . and this will increase receipts. Demand Elasticity and Revenue There is a relationship between the price elasticity of demand and revenue received. then the quantity effect is stronger and will more than offset the opposite price effect. marginal revenue reaches zero. A decrease in price would decrease revenue if nothing else were to happen. What does that entail for revenue? If price decreases and. by substituting the good in question for another (if the price has fallen). When total revenue reaches its peak (elasticity equals 1). (and therefore the coefficient will be greater than I in absolute terms).

e. . Again. it is important for a manager to know how supply elasticity affects price and quantity when demand changes. the more quantity supplied will change (in percentage terms) in response to a change in price.. influenced by) consumers' income. the effect of a change in demand will be greater on quantity than on price of the product. a change in demand will have a greater effect on price than quantity. Es = Q 2−Q 1 P2 −P 1 ÷ (Q 2 +Q 1)/ 2 (P2 + P1)/ 2 is a positive number: quantity and price move in the same direction. What is the meaning of "related" products? In economics. The general expression for this elasticity is as follows: Ey = %ΔQ ÷ %ΔY where Y represents income. In contrast. this elasticity is a measure of the responsiveness of quantities produced by suppliers to a change in price. the arc coefficient of supply elasticity. When the supply curve is more elastic. Thus. Elasticity of Supply The price elasticity of supply measures the percentage change in quantity supplied as a result of a 1 percent change in price. The interpretation of the coefficient is the same as for the case of demand elasticity. we talk of two types of relationships: substitute good and complementary good. In other words. The definition of cross-elasticity is a measure of the percentage change in quantity demanded of product A resulting from a 1 percent change in the price of product B. This represents quantity of sales as a function of (i.(while everything else remains constant). The definition of income elasticity is a measure of the percentage change in quantity consumed resulting from a 1 percent change in income. The general equation can be written as E x= Δ Q A Δ PB ÷ QA PB Income Elasticity Income elasticity is a term we use to measure the sensitivity of demand for a product to changes in the income of the population. with a supply curve of low elasticity. The higher the coefficient. as in the case of demand elasticity.