DEMAND ANALYSIS-II

ELASTICITY OF
DEMAND
Slope of the Demand curve
 Market Demand Function
QDX = f(PX, N, I, PY, T)
QDX = quantity demanded of commodity X
PX = price per unit of commodity X
N = number of consumers on the market
I = consumer income
PY = price of related (substitute or
complementary) commodity
T = consumer tastes
Demand Curve Faced by a Firm Depends on
Market Structure
• Market demand curve
• Imperfect competition
• Firm’s demand curve has a negative slope
• Monopoly - same as market demand
• Oligopoly
• Monopolistic Competition
• Perfect Competition
• Firm is a price taker
• Firm’s demand curve is horizontal
Demand Curve Faced by a Firm Depends on the
Type of Product
• Durable Goods
• Provide a stream of services over time
• Demand is volatile
• Nondurable Goods and Services
• Producers’ Goods
• Used in the production of other goods
• Demand is derived from demand for final goods or services
Linear Demand Function

QX = a0 + a1PX + a2N + a3I + a4PY + a5T

PX Intercept:
a0 + a2N + a3I + a4PY + a5T

Slope:
QX/PX = a1

QX
Linear Demand Function Example Part 1

Demand Function for Good X

QX = 160 - 10PX + 2N + 0.5I + 2PY + T

Demand Curve for Good X

Given N = 58, I = 36, PY = 12, T = 112
Q = 430 - 10P
Linear Demand Function Example Part 2

Inverse Demand Curve

P = 43 – 0.1Q
Total and Marginal Revenue Functions
TR = 43Q – 0.1Q2
MR = 43 – 0.2Q
Price Elasticity of Demand

Q / Q Q P
Point Definition EP   
P / P P Q
Price Elasticity of Demand

Q2  Q1 P2  P1
Arc Definition EP  
P2  P1 Q2  Q1
Marginal Revenue and Price Elasticity of
Demand

 1 
MR  P 1  
 EP 
Marginal Revenue and Price Elasticity of
Demand

PX
EP  1
EP  1

EP  1

QX
MRX
Determinants of Price Elasticity of
Demand
The demand for a commodity will be more price elastic
if:
• It has more close substitutes
• It is more narrowly defined
• More time is available for buyers to adjust to a price
change
Determinants of Price Elasticity of
Demand
The demand for a commodity will be less price elastic if:
• It has fewer substitutes
• It is more broadly defined
• Less time is available for buyers to adjust to a price
change
Income Elasticity of Demand

Q / Q Q I
Point Definition EI   
I / I I Q
Income Elasticity of Demand

Q2  Q1 I 2  I1
Arc Definition EI  
I 2  I1 Q2  Q1

Normal Good Inferior Good

EI  0 EI  0
Cross-Price Elasticity of Demand

QX / QX QX PY
Point Definition E XY   
PY / PY PY QX
Cross-Price Elasticity of Demand

QX 2  QX 1 PY 2  PY 1
Arc Definition E XY  
PY 2  PY 1 QX 2  QX 1

Substitutes Complements
EXY  0 EXY  0
QUESTIONS?