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Program: GM 2
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.
price and quantity are inversely related. That is, the quantity demanded of the commodity
increases when its price falls and decreases when its price rises. We can express the general
market
demand
function for commodity X as:
QDx = F (Px, N, I, Py, T)
Finally, 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.
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, the form in which the industry is organized, and the number
firms in the industry. If the firm is the sole producer of a commodity for which there are no good
substitutes (i.e, if the firm is a monopolist), the firm is or represent the industry, and it faces the
industry or market demand for the commodity. We can specify the linear form of the demand
function faced by a firm as:
Qx = a0 + a1Px + a2N + a3I + a4Py + a5T + ..
Where Qx refers quantity demanded of commodity X per time period faced by the firm, and Px,
N, I, Py, T refer, as before, to the price of the commodity, the number of consumers in the market,
consumers incomes, the price of related commodities, and consumers tastes, respectively. The
as represent the coefficients to be estimated by regression analysis, which is the most used
technique for estimating demand. 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.
Percent charge A
Percent chargeB
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. We can write the
expression, "percentage change in quantity demanded" as:
Quantity demanded
Initial Quantity Demanded
Where (delta) signifies an absolute change. The second part of this relationship, percentage
charge in price, can be written as:
Quantity Price
Initial Price
Dividing the first expression by the second, we arrive at the expression for the price
elasticity of demand:
Quantity Price Quantity
=
Quantity
Price
Price
Q2Q1
P2P1
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).
When total revenue reaches its peak (elasticity equals 1), marginal revenue reaches zero.
(while everything else remains constant). What is the meaning of "related" products? In
economics, we talk of two types of relationships: substitute good and complementary good. 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. The general equation can
be written as
E x=
Q A 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. This represents quantity of sales as a function of (i.e., influenced
by) consumers' income. The general expression for this elasticity is as follows:
Ey = %Q %Y
where Y represents income. The definition of income elasticity is a measure of the percentage
change in quantity consumed resulting from a 1 percent change in income.
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. In other words, this elasticity is a measure of the responsiveness of
quantities produced by suppliers to a change in price. Thus, the arc coefficient of supply
elasticity,
Es =
Q 2Q 1
P2 P 1