CH 15 Market Demand

Chapter 15
Market Demand
1
From Individual to Market
Demand Functions
◆  Think of an economy containing n
consumers, denoted by i = 1, … ,n.
◆  Consumer i’s ordinary demand
function for commodity j is
x*ji (p1 , p2 , mi )
2
Demand Functions
◆  When all consumers are price-takers,
the market demand function for
commodity j is
n *i
X j (p1 , p2 , m ,!, m ) = ∑ x j (p1 , p2 , mi ).
1 n
i= 1
◆  If all consumers are identical then
X j (p1 , p2 , M) = n × x*j (p1 , p2 , m)
where M = nm.
3
Demand Functions
◆  The market demand curve is the
“horizontal sum” of the individual
consumers’ demand curves.
◆  E.g. suppose there are only two
consumers; i = A,B.
4
Demand Functions
p1 p1
p1’ p1’
p1” p1”
20 x*A 15 *B
x1
1
5
Demand Functions
p1 p1
p1’ p1’
p1” p1”
20 x*A 15 *B
x1
p1 1
p1’
x*1A + xB
1 6
Demand Functions
p1 p1
p1’ p1’
p1” p1”
20 x*A 15 *B
x1
p1 1
p1’
p1”
x*1A + xB
1 7
Demand Functions
p1 p1
p1’ p1’
p1” p1”
20 x*A 15 *B
x1
p1 1
p1’ The “horizontal sum”

p1” of the demand curves
of individuals A and B.
35
x*1A + xB
1 8
Elasticities
◆  Elasticitymeasures the “sensitivity”
or “responsiveness” of one variable
with respect to another.
◆  The elasticity of variable X with
respect to variable Y is
% Δx
ε x,y = .
% Δy
9
Economic Applications of
Elasticity
◆  Economists use elasticities to
measure the sensitivity of
– quantity demanded of commodity i
with respect to the price of
commodity i (own-price elasticity
of demand)
– demand for commodity i with
respect to the price of commodity j
(cross-price elasticity of demand).
10
Elasticity
– demand for commodity i with
respect to income (income
elasticity of demand)
– quantity supplied of commodity i
with respect to the price of
commodity i (own-price elasticity
of supply)
11
Elasticity
– quantity supplied of commodity i
with respect to the wage rate
(elasticity of supply with respect to
the price of labor)
– and many, many others.
12
Own-Price Elasticity of Demand
◆  Q:Why not use a demand curve’s
slope to measure the sensitivity of
quantity demanded to a change in a
commodity’s own price?
13
p1 p1
slope slope
10 =-2 10 = - 0.2
5 X1* 50 X *
1
In which case is the quantity demanded

X1* more sensitive to changes to p1?
14
p1 p1
slope slope
10 =-2 10 = - 0.2
5 X1* 50 X *
1

15
10-packs Single Units
p1 p1
slope slope
10 =-2 10 = - 0.2
5 X1* 50 X *
1

16
10-packs Single Units
p1 p1
slope slope
10 =-2 10 = - 0.2
5 X1* 50 X *
1

It is the same in both cases.
17
◆  Q: Why not just use the slope of a
demand curve to measure the
sensitivity of quantity demanded to a
change in a commodity’s own price?
◆  A: Because the value of sensitivity
then depends upon the (arbitrary)
units of measurement used for
quantity demanded.
18
*
% Δx1
ε x* ,p =
1 1 % Δp1
is a ratio of percentages and so has no
units of measurement.
Hence own-price elasticity of demand is
a sensitivity measure that is independent
of units of measurement.
19
Arc and Point Elasticities
◆  An “average” own-price elasticity of
demand for commodity i over an
interval of values for pi is an arc-
elasticity, usually computed by a
mid-point formula.
◆  Elasticity computed for a single
value of pi is a point elasticity.
20
Arc Own-Price Elasticity
pi What is the “average” own-price
elasticity of demand for prices
in an interval centered on pi’?
pi’+h
pi’
pi’-h
Xi*
21
pi’+h
pi’
pi’-h
Xi" Xi '" Xi*
22
pi’+h
pi’ *
% ΔXi
ε X* ,p =
pi’-h i i % Δpi
Xi" Xi '" Xi*
23
pi’+h
pi’ *
% ΔXi
ε X* ,p =
pi’-h i i % Δpi
Xi" Xi '" Xi*

2h
% Δpi = 100 ×
pi '
24
pi’+h
pi’ *
% ΔXi
ε X* ,p =
pi’-h i i % Δpi
Xi" Xi '" Xi*

2h * ( Xi"− Xi '")
% Δpi = 100 × % ΔXi = 100 ×
pi ' ( Xi"+ Xi '") / 2
25
2h
% Δpi = 100 ×
* pi '
% ΔXi
ε X* ,p =
i i % Δpi ( Xi"− Xi '")
% ΔX*i = 100 ×
( Xi"+ Xi '") / 2
26
2h
% Δpi = 100 ×
* pi '
% ΔXi
ε X* ,p =
i i % Δpi ( Xi"− Xi '")
% ΔX*i = 100 ×
( Xi"+ Xi '") / 2
So
%ΔX*i pi ' ( Xi "− Xi '" )
ε X* ,p = = × .
i i %Δpi ( Xi "+ Xi '" ) / 2 2h
is the arc own-price elasticity of demand.
27
Point Own-Price Elasticity
pi What is the own-price elasticity
of demand in a very small interval
of prices centered on pi’?
pi’+h
pi’
pi’-h
Xi" Xi '" Xi*

*
%ΔXi pi ' ( Xi "− Xi '" )
ε X* ,p = = × .
i i %Δpi ( Xi "+ Xi '" ) / 2 2h
28
What is the own-price elasticity
pi of demand in a very small interval
pi’+h As h → 0,
pi’
pi’-h
Xi" Xi '" Xi*

*
%ΔXi pi ' ( Xi "− Xi '" )
ε X* ,p = = × .
i i %Δpi ( Xi "+ Xi '" ) / 2 2h
29
pi’+h As h → 0,
pi’
pi’-h
Xi" Xi '" Xi*

*
%ΔXi pi ' ( Xi "− Xi '" )
ε X* ,p = = × .
i i %Δpi ( Xi "+ Xi '" ) / 2 2h
30
pi’+h As h → 0,
pi’
pi’-h
Xi ' Xi*
*
%ΔXi pi ' ( Xi "− Xi '" )
ε X* ,p = = × .
i i %Δpi ( Xi "+ Xi '" ) / 2 2h
31
As h → 0,
pi’ pi ' dX*i
ε X* ,p → ×
i i Xi ' dpi
Xi ' Xi*
*
%ΔXi pi ' ( Xi "− Xi '" )
ε X* ,p = = × .
i i %Δpi ( Xi "+ Xi '" ) / 2 2h
32
*
pi ' dXi
ε X* ,p = ×
pi’ i i Xi ' dpi
is the elasticity at the
point ( Xi ', pi ').
Xi ' Xi*
33
*
pi dXi
ε X* ,p = * ×
i i Xi dpi
E.g. Suppose pi = a - bXi.

Then Xi = (a-pi)/b and
*
dXi 1
= − . Therefore,
dpi b
pi ⎛ 1⎞ pi
ε X* ,p = × ⎜− ⎟ = − .
i i ( a − pi ) / b ⎝ b⎠ a − pi
34
pi pi = a - bXi*
a/b Xi*
35
pi
pi pi = a - bXi* ε X* ,p = −
i i a − pi
a
a/b Xi*
36
pi
pi pi = a - bXi* ε X* ,p = −
i i a − pi
a
p= 0⇒ε =0
a/b Xi*
37
pi
pi pi = a - bXi* ε X* ,p = −
i i a − pi
a
p= 0⇒ε =0
ε=0
a/b Xi*
38
pi
pi pi = a - bXi* ε X* ,p = −
i i a − pi
a a a/2
p= ⇒ε =− = −1
2 a−a/2
ε=0
a/b Xi*
39
pi
pi pi = a - bXi* ε X* ,p = −
i i a − pi
a a a/2
p= ⇒ε =− = −1
2 a−a/2
a/2 ε = −1
ε=0
a/2b a/b Xi*
40
pi
pi pi = a - bXi* ε X* ,p = −
i i a − pi
a a
p=a⇒ε = − = −∞
a−a
a/2 ε = −1
ε=0
a/2b a/b Xi*
41
pi
pi pi = a - bXi* ε X* ,p = −
i i a − pi
a ε = −∞ a
p=a⇒ε = − = −∞
a−a
a/2 ε = −1
ε=0
a/2b a/b Xi*
42
pi
pi pi = a - bXi* ε X* ,p = −
i i a − pi
a ε = −∞
own-price elastic
a/2 ε = −1
own-price inelastic
ε=0
a/2b a/b Xi*
43
pi
pi pi = a - bXi* ε X* ,p = −
i i a − pi
a ε = −∞
own-price elastic
a/2 ε = −1 (own-price unit elastic)
own-price inelastic
ε=0
a/2b a/b Xi*
44
*
pi dXi
ε X* ,p = * ×
i i Xi dpi
dX*i
E.g. X*i = kpia . Then =a kp a-1
i
dp i
so a
pi a −1 pi
ε X* ,p = × kapi =a = a.
a a
i i kpi pi
45
pi * a −2 k
Xi = kpi = kpi =
2
pi
ε = −2 everywhere along
the demand curve.
Xi*
46
Revenue and Own-Price
Elasticity of Demand
◆  Ifraising a commodity’s price
causes little decrease in quantity
demanded, then sellers’ revenues
rise.
◆  Hence own-price inelastic demand
causes sellers’ revenues to rise as
price rises.
47
◆  Ifraising a commodity’s price causes
a large decrease in quantity
demanded, then sellers’ revenues
fall.
◆  Hence own-price elastic demand
causes sellers’ revenues to fall as
price rises.
48
*
Sellers’ revenue is R ( p ) = p × X (p ).
49
*
*
dR dX
So = X* (p) + p
dp dp
50
*
*
dR dX
So = X* (p) + p
dp dp
⎡ *⎤
* p dX
= X (p )⎢1 + ⎥
*
⎢⎣ X (p ) dp ⎥⎦
51
*
*
dR dX
So = X* (p) + p
dp dp
⎡ *⎤
* p dX
= X (p )⎢1 + ⎥
*
⎢⎣ X (p ) dp ⎥⎦
= X* (p)[1 + ε ].
52
dR
= X* (p)[1 + ε ]
dp
53
dR
= X* (p)[1 + ε ]
dp
dR
so if ε = −1 then =0
dp
and a change to price does not alter

sellers’ revenue.
54
dR
= X* (p)[1 + ε ]
dp
dR
but if − 1 < ε ≤ 0 then >0
dp
and a price increase raises sellers’

revenue.
55
dR
= X* (p)[1 + ε ]
dp
dR
And if ε < −1 then <0
dp
and a price increase reduces sellers’

revenue.
56
In summary:
Own-price inelastic demand; − 1 < ε ≤ 0
price rise causes rise in sellers’ revenue.
Own-price unit elastic demand; ε = −1
price rise causes no change in sellers’
revenue.
Own-price elastic demand; ε < −1
price rise causes fall in sellers’ revenue.
57
Marginal Revenue and Own-
Price Elasticity of Demand
◆  Aseller’s marginal revenue is the rate
at which revenue changes with the
number of units sold by the seller.
dR( q)
MR( q) = .
dq
58
p(q) denotes the seller’s inverse
demand function; i.e. the price at which
the seller can sell q units. Then
R( q) = p( q) × q
so dR( q) dp( q)
MR( q) = = q + p( q)
dq dq
⎡ q dp( q) ⎤
= p( q) ⎢1 + ⎥ .
⎣ p( q) dq ⎦
59
⎡ q dp( q) ⎤
MR( q) = p( q) ⎢1 + .
⎣ p( q) dq ⎥⎦
dq p
and ε= ×
dp q
⎡ 1⎤
so MR( q) = p( q) ⎢1 + ⎥ .
⎣ ε⎦
60
⎡ 1⎤
MR( q) = p( q) ⎢1 + ⎥ says that the rate
⎣ ε⎦
at which a seller’s revenue changes
with the number of units it sells
depends on the sensitivity of quantity
demanded to price; i.e., upon the
value of the own-price elasticity of
demand.
61
⎡ 1⎤
MR(q) = p(q)⎢1 + ⎥
⎣ ε⎦
If ε = −1 then MR( q) = 0.
If − 1 < ε ≤ 0 then MR( q) < 0.
If ε < −1 then MR( q) > 0.
62
If ε = −1 then MR( q) = 0. Selling one
more unit does not change the seller’s
revenue.
If − 1 < ε ≤ 0 then MR( q) < 0. Selling one
more unit reduces the seller’s revenue.
If ε < −1 then MR( q) > 0. Selling one
more unit raises the seller’s revenue.
63
An example with linear inverse demand.
p( q) = a − bq.
Then R( q) = p( q)q = ( a − bq)q

and MR( q) = a − 2bq.
64
p
p( q) = a − bq
a/2b a/b q
MR( q) = a − 2bq
65
p
a Price Elasticity of Demand
MR( q) = a − 2bq
p( q) = a − bq
$ a/2b a/b q
R(q)
a/2b a/b q
66

CH 15 Market Demand

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CH 15 Market Demand

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Chapter 15

p1’ The “horizontal sum”

In which case is the quantity demanded

In which case is the quantity demanded

In which case is the quantity demanded

In which case is the quantity demanded

Xi" Xi '" Xi*

Xi" Xi '" Xi*

Xi" Xi '" Xi*

Xi" Xi '" Xi*

Xi" Xi '" Xi*

Xi" Xi '" Xi*

Xi" Xi '" Xi*

E.g. Suppose pi = a - bXi.

a/2b a/b Xi*

a/2b a/b Xi*

a/2b a/b Xi*

a/2b a/b Xi*

a/2b a/b Xi*

and a change to price does not alter

and a price increase raises sellers’

and a price increase reduces sellers’

Then R( q) = p( q)q = ( a − bq)q

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