Professional Documents
Culture Documents
I. Demand
II. Law of Demand
III.Determinants of Demand
IV. Demand Function
1.
Linear Function
2.
Multiplicative Function
V. Demand Curve Function
1.
How to derive the demand curve function
from a demand function
VI.
Market
Equilibrium
Price
and
Elasticities of Demand :
1.
Price Elasticity of Demand
2.
Income Elasticity of Demand
3. Cross Elasticity of Demand
4. Advertising Elasticity of Demand
CHAPTER 3 : DEMAND ANALYSIS
21
I.
Demand
It is the quantity of a good or service that customers are willing and able
to buy
II.
Law of Demand
There is an inverse/negative relationship between price and quantity
demanded for a product, ceteris paribus.
When price increases, quantity demanded decreases and vice versa.
Price, P
Demand
Quantity, Q
Diagram 1 : Demand Curve
III.
Determinants of Demand
There are factors that influence demand for a product.
Examples of determinants of demand are:
1.
2.
3.
4.
5.
6.
IV.
Demand Function
22
where,
QX
f(PX, A, I, T, .)
PX
A
I
T
=
=
=
=
price of product x
advertising expenditure
income per capita
taste of consumers
Linear Function
QX = a - b1PX
+ b2PY
+ b3Y
Multiplicative Function
QX
aPXb1PYb2Yb3
b1PX
23
=
a
b1PX
=
a
QX
=
(a/ b1)
(QX / b1)
(conventional demand curve function)
Example:
Assume the estimated demand function is
QX = 2 - 3PX + 2I + 3PY + T
Given PX = 2, I = 4, PY = 3 and T = 1
i)
ii)
VI
Relationship among
Marginal Revenue
1.
= 20 3 PX
= 20 - QX
= 20/3 - QX /3
Total
Revenue,
Average
Revenue
and
= a bP
= a/b 1/b Q
From Table 1, the slope of marginal revenue is twice the slope of average
revenue or price.
Total Revenue
TR = P x Q
TR = (a/ b - 1/ b Q) x Q
TR = a/b Q 1/b Q2
i)
Average Revenue
AR
AR
AR
AR
=
=
=
=
TR/Q
(P x Q) / Q
P
a/b 1/b Q
Marginal Revenue
MR = dTR/dQ
MR=d(a/b Q1/b Q2) /dQ
MR = a/b 2/b Q
24
Example:
P
TR
TR
TR
ii)
=
=
=
=
6.5 - 0.5Q
PxQ
(6.5 0.5Q) x Q
6.5Q - 0.5Q2
iii)
=
=
6.5Q d(TR)/dQ
0.5Q2
=
6.5 - Q
=
=
=
6.5Q - 0.5Q2
TR/Q = (6.5Q
6.5 - 0.5Q
- 0.5Q2)/ Q
Note:
Total Revenue, marginal revenue and average revenue
functions must be in the form of Q
25
2.
Curves
P, MR
6.5
P = AR = D
MR
6.5
13
TR
TR is max; MR = 0
TR is increasing; MR +ve
TR is decreasing; MR -ve
TR
Diagram 2 : Total
and Marginal
6.5Revenue, Average Revenue
13
Q
Revenue Curves
26
VII
=
=
=
30
22.5
37.5
P
0.75P
1.25P
The market demand curve function, assuming that there are only three
individuals in the market, is
QM
QM
QM
VIII
=
=
=
Q1
+
Q2
+
Q3
(30 P) + (22.5 0.75P) + (37.5 1.25P)
90
3P
OR
Q D = QS
Example:
Given QD = 10 PA and QS = 2 + PB
Market equilibrium price & quantity:
QP
D
10 PA
2P
P
4
substitute
= QS
= 2 + PB
=8
=4
P = 4 into QD or QS
Q = 10 4 = 6
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Elasticities of Demand
Elasticity is the measurement of the percentage change in one variable
that results from a 1% change of another variable.
Elasticity of demand measures the sensitivity of quantity demanded to
changes in its determinants.
Two ways of measuring elasticity:
Arc elasticity - measures over a range of output
Point elasticity- measures over very small range of output
1.
P2 + P1
Q 2 + Q1
28
lEpl
>
lEpl
<
lEpl
unitary
elastic
(proportionately
sensitive to price change)
lEpl
lEpl
perfectly elastic
change)
price
price
(very
sensitive
to
lEpl
= dQX x PX
dPX
QX
= -2 x (2 / 11)
= 4/11 (inelastic)
ii)
29
between
price
elasticity
and
total
availability of substitutes
many substitutes more elastic
b)
c)
30
d)
2.
types of goods
necessity more inelastic
luxury more elastic
Y2 + Y1
Q 2 + Q1
Ey 1
Ey
= dQX x Y
dY
QX
= 2 x (4 / 11)
= 8/11
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ii)
cycle
(peak,
contraction,
Promotional strategies
Normal product can be advertised in daily media but
expensive products should be advertised in a media
that reaches the rich people.
3.
EXY
= dQX x PY
dPY
QX
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= 1 x (3 / 11)
= 3/11
the 2 goods are substitutes because E XY > 0 (weak
substitutes)
OR
the 2 goods are not related because EXY is very close to zero
4.
PRACTICE QUESTIONS
33
1.
2.
:
:
:
P
P
P
= 35 0.5QA
= 50 0.25QB
= 40 2.00QC
34