Chapter 2 Demand Theory

Chapter Review

 The market demand curve for a product shows how much of the product is demanded at
each price. The market demand curve shifts in response to changes in tastes, incomes,
prices of other products, advertising, and the size of the population.

 The market demand function for a product is an equation showing how the quantity
demanded depends on the product's price, the incomes of consumers, the prices of other
products, advertising expenditure, and additional factors. Holding all factors other than
the product's price constant, we can draw the market demand curve for the product from
the market demand function. Market demand functions are formulated for individual
firms as well as for entire industries.

 The own-price elasticity of demand is the percentage change in quantity demanded

resulting from a 1% change in price; more precisely, it equals (ΔQ/ΔP)(P/Q). Whether a
price increase (or decrease) results in an increase in the total amount spent by consumers
on a product depends on the own-price elasticity of demand.

 Marginal revenue is the change in total revenue resulting from a one-unit increase in
quantity. Marginal revenue equals P(1 + 1/η), where P is price and η is the own-price
elasticity of demand.

 The own-price elasticity of demand for a product tends to be elastic if the product has
many close substitutes. In addition, it often tends to be more elastic in the long run than
in the short run. It is sometimes asserted a product's demand is relatively price inelastic if
the product accounts for a very small percentage of the typical consumer's budget, but
this need not be the case.

 The income elasticity of demand is the percentage change in quantity demanded resulting
from a 1% change in consumer income; that is, it equals (ΔQ/ΔI)(I/Q), where I is the
income of consumers. The income elasticity of demand may be positive or negative. Like
the price elasticity of demand, it is of major importance in forecasting the long-term
growth in the quantity demanded for products.

 The cross-price elasticity of demand is the percentage change in the quantity demanded
of product X resulting from a 1% change in the price of product Y; in other words, it
equals (ΔQX/ΔPY)(PY/QX). If X and Y are substitutes, it is positive; if they are
complements, it is negative. This elasticity is important for managers because they must
understand and forecast the effects of changes in other firms' prices on their own firm's
sales.

 If a demand curve is linear, the own-price elasticity of demand varies from point to point
on the demand curve. As price approaches zero, the own-price elasticity of demand also
approaches zero. As quantity demanded approaches zero, the own-price elasticity
 approaches negative infinity. In contrast, for a constant-elasticity demand function, the
own-price elasticity of demand is the same regardless of the product's price.

1. The president of a leading producer of tantalum says that an increase in the price of
tantalum would have no effect on the total amount spent on tantalum. If this is true, the
price elasticity of demand for tantalum is

1. greater than zero.

2. minus one.

3. minus two.

4. less than minus one.

5. None of the given choices are correct.

2. A demand curve with unitary elasticity at all points is

1. a straight line.

2. a parabola.

3. a hyperbola.

4. All of the given choices are correct.

5. None of the given choices are correct.

3. It is always true that ηxy=ηyx.

1. True

2. False

4. The income elasticity of demand for food is very high.

1. True
 2. False

5. Under a linear demand function, as price increases, the price elasticity of demand
becomes less elastic.

1. True

2. False

6. If a firm is on a portion of its demand curve that is price inelastic, it cannot be

maximizing profits.

1. True

2. False

7. Marginal revenue is the ratio of the value of sales to the amount sold.

1. True

2. False

8. The relationship between marginal revenue and the price elasticity of demand is

1. MR = P(1 + 1/ η).

2. P = MR(1+ 1/ η).

3. P = MR(1 – η).

4. MR = P(1 – η).

5. None of the given choices are correct.

9. The demand for a good is price inelastic if

1. the price elasticity is minus one.

 2. the price elasticity is less than minus one.

3. the price elasticity is greater than minus one.

4. All of the given choices are correct.

5. None of the given choices are correct.

10 In general, demand is likely to be more inelastic in the long run than in the short run
(for nondurable goods).

1. True

2. False

11. If a good’s income elasticity exceeds one, a decrease in the price of the good will
increase the total amount spent on it.

1. True

2. False

12. The income elasticity of demand will always have the same sign regardless of the level
of income at which it is measured.

1. True

2. False

13. When the demand curve is linear, the slope of the marginal revenue curve is twice (in
absolute value) the slope of the demand curve.

1. True
 2. False

14 Suppose we are concerned with the relationship between the quantity of food demanded
and aggregate income. It seems most likely that this relationship will look like

1. curve A above.

2. curve B above.

3. curve C above.

4. the vertical axis.

5. the horizontal axis.

15. The demand for salt and pepper is likely to be price elastic.

1. True
 2. False

16 If goods X and Y are substitutes, the relationship between the quantity demanded of good X and
the price of good Y should be like

1. curve A above.

2. curve B above.

3. the vertical axis.

4. the horizontal axis.

5. None of the given choices are correct.

17. The direct approach of simply asking people how much they would buy of a particular
commodity is the best way to estimate the demand curve.

1. True
 2. False

18. The demand for open-heart surgery is likely to be less price elastic than the demand for
aspirin.

1. True

2. False

Answer:

Chapter 2 Demand
1 2 3 4 5 6 7 8 9 10
A C False Fasle Fasle True Fasle A C Fasle
11 12 13 14 15 16 17 18
Fasle False True B False B B True

1.