Microeconomics Chapter6

To ALL STUDENTS
Before you Study After you Study

these Slides these Slides
Review pages 21-25 in the applications to:
Read answers to questions 1 and 2 in
the textbook.
Read the solutions to question and
problem 3 on pages 24-25 in the
Revise Chapter 4 including slides applications.
and applications by the assistants On your own solve question 2 on pages
23-24 in the applications
Read the case study of Starbucks on
pages 22-23 in the applications and
solve the questions on page 23
Market Demand chapter 6
Basic Facts
 The market demand curve is the sum of all individual consumer demands curves
 The market demand function is the sum of all individual demand functions
 The demand function is the mathematical presentation of the demand curve
 Both the demand function and demand curve give a negative relationship between the
quantity demanded of a good and its own price
 The demand law states that “ by holding all other things constant, the relationship
between the quantity demanded of a good and its own price is negative”.
 Therefore, demand curve, demand function and demand law represent the same
thing: “the negative relationship between quantity demanded and price”
Consumer Desire or preference is represented by the indifference curves:

Demand Function
The General form of the demand function is:
Where,
is the quantity demanded of .
is the price of (own price).
represents prices of other goods (substitutes or complements).
is money income.
represents any other variables that affect demand.
Demand Function
If h(prices of other goods),(money income) and (other variables) are held
constant, the demand function will be reduced to a relationship between
(the quantity demanded) and (own price) as follows:
Or:
Where,
• is a constant representing the impact of other variables.
• is the slope of the demand function that gives the change in the quantity demanded
for one unit change in price, or .
Market Demand Curve

 Market demand curve is the graphical presentation of the demand function.
 Graphing the demand function on the previous slide, gives the following demand
curve:
𝑷𝒙
𝒃
𝜶
𝟎 𝜶 𝑸𝒙
Market Demand Curve
Any point on the demand curve means that:

 Consumer have the desire and ability to buy. Therefore,
The demand curve reflects the desire of consumers
 Optimal choice by consumers
Consumers realize maximum satisfaction
 Consumer are willing to pay.
The demand curve gives the willingness to pay
 At point consumers are willing to pay the maximum price. This point is called the “deprivation
point” where no quantity of the good is available. In a state of deprivation, the satisfaction of one
unit of the good is unlimited
 At point the consumers are willing to pay nothing for this last unit, simply because it gives them zero
satisfaction.
Elasticity
 The demand function gives the negative relationship between quantity
demanded and price .
 If price changes (increases or decreases) the quantity demanded will
respond.
But
By how much the quantity demanded responds (reacts) of price changes
by 1%? In other words, if price increases by 1%, by how much quantity will
decrease?. This is known as the price elasticity of demand.
Elasticity:
is the degree of responsiveness of one variable (the dependent
variable) to changes in another variable (the independent
variable).
The degree of responsiveness is the percentage change. Therefore,
elasticity can be calculated as follows:
Price Elasticity of demand:

is the degree of responsiveness of quantity demanded of a good
(the dependent variable) to changes in its own price (the
independent variable).
Price Elasticity of Demand and total Revenue

 Total Revenue is simply the product of price and quantity :
 is the quantity produced and sold or it is the quantity demanded
 If changes (increases or decreases) will also change
 Change in will result in two different changes in : direct and indirect
 If (for example) increases, then:
- will directly increase Direct effect

- will decrease (according to the demand law) and, therefore, will decrease Indirect effect
+ve direct -ve

effect
-ve indirect effect
 A price increase will directly cause an increase in total revenue.

 A price increase will also cause a decrease in the quantity demanded
 The decrease in quantity demanded will cause a decrease in total revenue
 The overall effect of an increase in price will depend on the degree of
responsiveness of quantity demanded to the increase in price, or the price
elasticity of demand.
Price Elasticity of Demand and total Revenue: an Example

The following are the demand curves for apple in two markets:
𝑷
𝑷
𝐵
𝟓𝟓
𝐵
𝟓𝟓
𝟓𝟎
𝐸
𝟓𝟎
𝐸
𝑸 𝑸
𝟑𝟎𝟎 𝟓𝟎𝟎 𝟐𝟎𝟎𝟏𝟗𝟎
Market A Market B
Demand for apple in two markets

Change in total revenue following the increase in price from 50 t0 55:

Total Revenue

Change in Price elasticity of
Before After total demand
Market Change in Change in revenue
𝐸
price
(point E)
price
(point B)

A 25000 10000 -8500 -4

B 16500 10450 +450 -0.5

The above table shows that an increase in price by 5 causes total revenue to
decrease by 8500 in market A and increase by 450 in market B. This final impact of
change in price on total revenue is the sum of two changes in total revenue as
follows:
1. The direct increase in total revenue due to the increase in price. This change in
𝐸
total revenue is represented by the red area (area 1) on the next slide and is
calculated as follows:
• In market A:
• In market B:
𝑷
𝑷
𝟏𝟐 𝟏𝟐
1
𝟏𝟎 𝟏𝟎 1

2 2
𝑸 𝑸
𝟒𝟎 𝟏𝟎𝟎 𝟏𝟎𝟎𝟗𝟎
Market A Market B
Direct and indirect impact of price changes on
total revenue
2. The indirect decrease in total revenue due to the decrease in the

quantity demanded following the increase in price. is represented by
the blue area (area 2) on the previous slide and is calculated as
follows: 𝐸
• In market A:
• In market B:

Summing up the two changes (direct plus indirect) in total revenue following a change in
price gives:
The change in total revenue with respect to change in price will be: (this is
done by dividing both side by )
Price Elasticity of Demand and total Revenue:

Multiplying the left hand side by

is the price elasticity of demand
Therefore,
Because the sign of is negative, then:


Conclusion:
• The relationship between total revenue and price will be positive if the value of the
price elasticity of demand is smaller than 1 (if demand is inelastic).
• The relationship between total revenue and price will be negative if the value of the
price elasticity of demand is greater than 1 (if demand is elastic).
• There will be no relationship between total revenue and price (i.e. there will be no
change in total revenue if price changes) if the value of the price elasticity of demand
is equal to 1.

Microeconomics Chapter6

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Microeconomics Chapter6

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To ALL STUDENTS

Before you Study After you Study

Consumer Desire or preference is represented by the indifference curves:

Market Demand Curve

Any point on the demand curve means that:

Price Elasticity of demand:

Price Elasticity of Demand and total Revenue

- will directly increase Direct effect

Price Elasticity of Demand and total Revenue

+ve direct -ve

-ve indirect effect

 A price increase will directly cause an increase in total revenue.

Price Elasticity of Demand and total Revenue: an Example

Price Elasticity of Demand and total Revenue: an Example

A 25000 10000 -8500 -4

Price Elasticity of Demand and total Revenue: an Example

Price Elasticity of Demand and total Revenue: an Example

2. The indirect decrease in total revenue due to the decrease in the

Price Elasticity of Demand and total Revenue

Price Elasticity of Demand and total Revenue:

Price Elasticity of Demand and total Revenue

Because the sign of is negative, then:

Price Elasticity of Demand and total Revenue

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