Ch. 3-demand-theory
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Transcript of Ch. 3-demand-theory
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 1
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 2
Law of Demand
• Holding all other things constant (ceteris paribus), there is an inverse relationship between the price of a good and the quantity of the good demanded per time period.– Substitution Effect– Income Effect
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 3
Components of Demand:The Substitution Effect
• Assuming that real income is constant:– If the relative price of a good rises, then
consumers will try to substitute away from the good. Less will be purchased.
– If the relative price of a good falls, then consumers will try to substitute away from other goods. More will be purchased.
• The substitution effect is consistent with the law of demand.
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 4
Components of Demand:The Income Effect
• The real value of income is inversely related to the prices of goods.
• A change in the real value of income:– will have a direct effect on quantity
demanded if a good is normal.– will have an inverse effect on quantity
demanded if a good is inferior.
• The income effect is consistent with the law of demand only if a good is normal.
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 5
Individual Consumer’s DemandQdX = f(PX, I, PY, T)
quantity demanded of commodity X by an individual per time period
price per unit of commodity X
consumer’s income
price of related (substitute or complementary) commodity
tastes of the consumer
QdX =
PX =
I =
PY =
T =
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 6
QdX = f(PX, I, PY, T)
QdX/PX < 0
QdX/I > 0 if a good is normal
QdX/I < 0 if a good is inferior
QdX/PY > 0 if X and Y are substitutes
QdX/PY < 0 if X and Y are complements
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 7
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 8
Market Demand Curve
• Horizontal summation of demand curves of individual consumers
• Exceptions to the summation rules– Bandwagon Effect
• collective demand causes individual demand
– Snob (Veblen) Effect• conspicuous consumption• a product that is expensive, elite, or in short
supply is more desirable
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 9
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 10
Market Demand FunctionQDX = f(PX, N, I, PY, T)
quantity demanded of commodity X
price per unit of commodity X
number of consumers on the market
consumer income
price of related (substitute or complementary) commodity
consumer tastes
QDX =
PX =
N =
I =
PY =
T =
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 11
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
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 12
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
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 13
Linear Demand Function
QX = a0 + a1PX + a2N + a3I + a4PY + a5T
PX
QX
Intercept:a0 + a2N + a3I + a4PY + a5T
Slope:QX/PX = a1
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 14
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
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 15
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
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 16
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 17
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 18
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 19
Price Elasticity of Demand
/
/P
Q Q Q PE
P P P Q
Linear Function
Point Definition
1P
PE a
Q
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 20
Price Elasticity of Demand
Arc Definition 2 1 2 1
2 1 2 1P
Q Q P PE
P P Q Q
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 21
Marginal Revenue and Price Elasticity of Demand
11
P
MR PE
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 22
Marginal Revenue and Price Elasticity of Demand
PX
QX
MRX
1PE
1PE
1PE
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 23
Marginal Revenue, Total Revenue, and Price Elasticity
TR
QX
1PE MR<0MR>0
1PE
1PE MR=0
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 24
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
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 25
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
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 26
Income Elasticity of Demand
Linear Function
Point Definition/
/I
Q Q Q IE
I I I Q
3I
IE a
Q
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 27
Income Elasticity of Demand
Arc Definition 2 1 2 1
2 1 2 1I
Q Q I IE
I I Q Q
Normal Good Inferior Good
0IE 0IE
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 28
Cross-Price Elasticity of Demand
Linear Function
Point Definition/
/X X X Y
XYY Y Y X
Q Q Q PE
P P P Q
4Y
XYX
PE a
Q
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 29
Cross-Price Elasticity of Demand
Arc Definition
Substitutes Complements
2 1 2 1
2 1 2 1
X X Y YXY
Y Y X X
Q Q P PE
P P Q Q
0XYE 0XYE
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 30
Example: Using Elasticities inManagerial Decision Making
A firm with the demand function defined below expects a 5% increase in income (M) during the coming year. If the firm cannot change its rate of production, what price should it charge?
• Demand: Q = – 3P + 100M– P = Current Real Price = 1,000– M = Current Income = 40
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 31
Solution
• Elasticities– Q = Current rate of production = 1,000– P = Price = - 3(1,000/1,000) = - 3– I = Income = 100(40/1,000) = 4
• Price– %ΔQ = - 3%ΔP + 4%ΔI– 0 = -3%ΔP+ (4)(5) so %ΔP = 20/3 = 6.67%– P = (1 + 0.0667)(1,000) = 1,066.67
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 32
Other Factors Related to Demand Theory
• International Convergence of Tastes– Globalization of Markets– Influence of International Preferences on
Market Demand
• Growth of Electronic Commerce– Cost of Sales– Supply Chains and Logistics– Customer Relationship Management
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 33
Chapter 3 Appendix
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 34
Indifference Curves
• Utility Function: U = U(QX,QY)
• Marginal Utility > 0– MUX = ∂U/∂QX and MUY = ∂U/∂QY
• Second Derivatives– ∂MUX/∂QX < 0 and ∂MUY/∂QY < 0
– ∂MUX/∂QY and ∂MUY/∂QX • Positive for complements• Negative for substitutes
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 35
Marginal Rate of Substitution
• Rate at which one good can be substituted for another while holding utility constant
• Slope of an indifference curve– dQY/dQX = -MUX/MUY
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 36
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 37
Indifference Curves:Complements and Substitutes
QY
QX
QY
QX
Perfect Complements
Perfect Substitutes
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 38
The Budget Line
• Budget = M = PXQX + PYQY
• Slope of the budget line– QY = M/PY - (PX/PY)QX
– dQY/dQX = - PX/PY
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 39
Budget Lines: Change in Price
GF: M = $6, PX = PY = $1
GF’: PX = $2
GF’’: PX = $0.67
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 40
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 41
Budget Lines: Change in Income
GF: M = $6, PX = PY = $1
GF’: M = $3, PX = PY = $1
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 42
Consumer Equilibrium
• Combination of goods that maximizes utility for a given set of prices and a given level of income
• Represented graphically by the point of tangency between an indifference curve and the budget line– MUX/MUY = PX/PY
– MUX/PX = MUY/PY
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 43
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 44
Mathematical Derivation
• Maximize Utility: U = f(QX, QY)
• Subject to: M = PXQX + PYQY
• Set up Lagrangian function– L = f(QX, QY) + (M - PXQX - PYQY)
• First-order conditions imply– = MUX/PX = MUY/PY
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 45
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 46