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Demand and elasticity (textbook) interval along the demand

A. The market demand curve curve


The determinants of demand
a) Price of product itself
b) Price of other products
complements and substitutes
c) Disposable incomes ii. Point elasticities
d) Tastes and preferences
e) Product advertisement
f) Advertising other products
complements and substitutes
g) Rate of interest
h) Availability of credit
i) Consumers expectations of
future prices and supplies

B. The demand curve


The term ceteris paribus is always
misunderstood, as other things are
always equal when it is not. A diagram
on a flat surface can only represent
two dimensions at a time, so that a
demand curve shows the links between
own-price and demand, for a fixed
combination of other factors.

When own-price changes,


results to a movement along
the demand curve.
Elastic = >1
When other determinant of
Inelastic = <1
demand changes, the
Infinitely inelastic = 0
Infinitely elastic = minus infinity
Unitary elasticity = -1

c. Links between and revenue

demand curve shifts.

C. Concepts of elasticity
a. Own-price elasticity of
demand
Qd When demand is elastic, between points X
PED = P and Y, marginal revenue is positive,
indicating that in order to sell one more unit
changequantity price of the commodity the price only has to fall by
or
change price quantity a very small proportion, so that total revenue
increases.
b. Arc and point elasticities
At the point Y where elasticity is equal to -1,
i. Arc elasticity: Elasticity
marginal revenue is zero, reflecting the fact
over a measurable
that revenue remains the same when price
changes.

Where demand is inelastic, between Y and Z,


marginal revenue is negative, showing that in
order to sell one additional unit of output the
proportionate change in price is so large that
revenue falls.

If demand is elastic, a fall in price leads


to a more than proportionate increase
in the quantity demanded, as a result
of which revenues will rise.
If demand is inelastic, a fall in price
leads to a less than proportionate
increase in the volume of demand and
revenues will fall.
When demand is elastic, revenues
move in the same direction as prices.

d. The determinants of own-


price elasticity
i. The existence of other
commodities with
similar price and
performance
characteristics
(substitutes)
The closer the substitutes available, the more
elastic the demand for the product will be.
The extent of elasticity will depend
upon how broadly the good in
question is defined. If more broadly
defined, more inelastic. Vice versa.

e. Income elasticity of demand


Income elasticity of demand =
percentage change quantity demanded
'
percentage changeconsumer s incomes

Arc income elasticity =

change quantity demanded consumer s ' incomes



changeconsumer s ' incomes quantity demanded

Luxury goods: little or nothing will be spent


at low levels of income, but once a threshold
level has been passed, consumption of such
goods will increase rapidly, indicating that
demand is income elastic, having an income
elasticity greater than 1.

Normal goods (necessities + luxury):


income elasticity is positive as consumption
increases with income.
Inferior goods: Income elasticity is negative If demand for the product as a whole is
as consumers choose purchase less of such perfectly elastic, individual firms will be
commodities as they have higher incomes. unable to sell their product at anything apart
from the indicated price.
f. Cross-price elasticities of 2. Degree of
demand product
Cross-price elasticity of demand: the differentiation /
responsiveness of the demand for a brand loyalty
commodity to change in the prices of other ( the part for
goods. purchases)
If products are highly differentiated and
XED = purchases are extremely loyal to a particular
percentage changethe quantity of good A demanded firm, the demand curve will be downward
percentage changethe price of good B sloping, rather than horizontal. Consumers
exhibit no brand loyalty, demand curves will
be horizontal lines as no consumer will be
Or prepared to pay more for the product of one
changequantity of A demanded price of B firm than for the product of another.

change price of B quantity of A 3. Share of the
market
If a firm has a very large market share, a
Positive XED (substitutes) = a fall in reduction in its price will need to attract a
the price of a substitute leads to a fall substantial proportion of other firms
in demand for the product being customers if the proportionate increase in its
considered. demand is to be large.
Negative XED (complements) Nevertheless, a firm with very small market
XED = 0, negligible interrelationship share will be able to induce a large
between the demand for two proportionate increase in it sales by
commodities attracting a relatively small proportion of its
rivals customers.
g. The demand curve for an 4. Rivals reactions
individual firm to its changes in
i. Pure monopoly price
industry If rivals react to a price reduction by
There is only one firm producing and there is increasing their output (and reducing their
no possibility of entry by other firms into the own price), then demand will be less
industry. The demand curve for the individual responsive than if rivals maintain or even
firm is the market demand curve for the reduce their output.
industry as a whole.

ii. Prefect competition


There are large number of firms in the
industry, all producing identical variants of
the product. Price will be set by the
interaction of supply and demand and each
individual firm will be able to sell as much as
it whishes at that price, but none at higher
prices. I.e Figure 7.3 (b)

iii. Markets which are


neither pure If the firm were to attempt to sell output
monopolies nor greater than Q0, it would have to reduce its
perfectly competitive price. This would lead rival firms to follow suit
1. Elasticity of and even a small increase in volume sold
market demand would require a relatively substantial fall in
for the product price. As a result, marginal revenue falls
as a whole.
dramatically for increases in volume beyond
Q0. The impact of the product on the
quality of the buyers product or
service
h. Elasticity of demand and the If the product sold is a key element in
power of buyers maintaining the quality or low cost of
i. Price sensitivity of buyers low product, they are unlikely
buyers to be price sensitive.
ii. Buyers bargaining
powers Customers own profitability
Price sensitivity Less price sensitivity
Purchases of the product as a
proportion of total purchases. Decision-makers incentives
If purchases of the product are an Purchasing managers within customer
unimportant proportion of buyers total companies face a variety of incentives,
purchases, they will tend to be some of which encourage them to be
relatively insensitive to price. more price sensitive, others of which
reduce the emphasis on price.
Product differences and brand identity
Reduce price sensitivity