Karina Demand Theory and Elasticity Summary

7/26/2019 Karina Demand Theory and Elasticity Summary

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Name: Karina Permata Sari (29115447) Program: GM 2

Business Economics Summar

!eman" #$eor an" E%asticit

#$e !eman" &or a 'ommo"it

The demand for a commodity arises from the consumers' willingness and ability (i.e., from their

desire or want for the commodity backed by the income purchase the commodity backed by the

income) to purchase the commodity. Consumer demand theory showed that the quantity

demanded of a commodity is a function of, or depends on, the price of the commodity, the

consumers income, the price of related (i.e., complementary and substitute) commodity, and

the tastes of the consumer. !n functional form, we can e"press this as

Qdx=f (Px,I, Py, T)

#here$

Qdx% quantity demanded of commodity & by an indiidualper time period (year, month, week,

day, or other unit of time)

Px%price per unit of commodity &

! % consumer income

Py% price of related (i.e., ubstituteand complementary) commodities

T % consumer taste

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. n the other hand, the quantity

demanded of a commodity declines with the opposite changes.

rom n"i*i"ua% to Mar+et !eman"

The market demand cure for a commodity is simply the hori*ontal summation of the demand

cures of all the consumers in the market. The market demand cure for a commodity shows the

arious quantities of the commodity demanded in the market per time period ( QDx) at arious

alternatie prices of the commodity, while holding eerything else constant. The market demand

cure for a commodity (+ust as an indiidual's demand cure) is negatiely sloped, indicating that


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price and quantity are inersely related. That is, the quantity demanded of the commodity

increases when its price falls and decreases when its price rises. #e can e"press the general

market demand

function for commodity & as$

QDx = F (Px, N, I, Py, T)

inally, it must be pointed out that a market demand cure is simply the hori*ontal summation of

the indiidual demand cures only if the consumption decisions of indiidual consumers are

independent.

#$e !eman" ace" , irm

The demand for a commodity faced by a particular firm depends on the si*e of the market or

industry demand for the commodity, the form in which the industry is organi*ed, and the number

firms in the industry. !f 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. #e can specify the linear form of the demandfunction faced by a firm as$

Qx= a0+ a1Px + a2N + a3I + a4Py+ a5T + ..

#here -" refers quantity demanded of commodity & 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, respectiely. 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 toproduce or meet the demand for the goods and serices that it sells.

#$e Economic 'once-t o& E%asticit

rice elasticity of demand showed the measurement of sensitiity in changing the quantity

demanded by the change of price. !n most general terms, we can define elasticity as a percentage

relationship between two ariables, that is, the percentage change in one ariable relatie to a

percentage change in another. !n different terms, we diide one percentage by the other$

Coefficient of elasticity % Percent charge

APercent chargeB

#$e Price E%asticit o& !eman"

#hen we speak of the price elasticity of demand, we are dealing with the sensitiity of quantities

bought to a change in the producer's price. Thus, this concept describes an action that is within

the producer's (or, in this case, the dealer's) control. ther elasticities discussed later are outside


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the producer's control and may eoke other actions on the producer's part to counteract them.

/emand price elasticity is defined as a percentage change in quantity demanded caused by a !

percent change in price. 0et us deelop this concept mathematically. #e can write the

e"pression, percentage change in quantity demanded as$

Quantitydemanded

Initial Quantity Demanded

#here 1 (delta) signifies an absolute change. The second part of this relationship, 2percentage

charge in price3, can be written as$

Quantity Price

InitialPrice

/iiding the first e"pression by the second, we arrie at the e"pression for the price

elasticity of demand$

Quantity

Quantity

Price

Price =

Quantity

Price

Measurement o& Price E%asticit an" !eterminants o& E%asticit

The formula indicator to measure price elasticity is as follows$

Ep= Q

2Q

1

(Q2+Q

1)/2

P2P

1

(P2+P

1)/2

4p% Coefficient of are price elasticity-5% riginal quantity demanded

-6% 7ew quantity demanded

5% riginal rice6% 7ew rice

actors affecting /emand 4lasticity are as follows$

4ase of ubstitution

roportion of total e"penditures

/urability of roduct

ossibility of postponing purchase

ossibility of repair

8sed product market

0ength of time period


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E%asticit in t$e S$ort./un an" in t$e 0ong./un

9 long:run demand cure will generally be more elastic than a short:run cure. ;ere short runis defined as an amount of time that does not permit a full ad+ustment by consumers to a price

change. !n the shortest of runs, no ad+ustment may be possible, and the demand cure oer the

releant range may be almost perfectly inelastic. 9s the time period lengthens, consumers willfind ways to ad+ust to the price change by using substitutes (if the price has risen), by substituting

the good in question for another (if the price has fallen), or by shifting consumption to or from

this particular product (i.e., by consuming more or less of other commodities).

!eman" E%asticit an" /e*enue

There is a relationship between the price elasticity of demand and reenue receied. 9 decrease

in price would decrease reenue if nothing else were to happen. emember that elasticity is defined as

the percentage change in quantity diided by the percentage change in price. !f the former is

larger, (and therefore the coefficient will be greater than ! in absolute terms), then the quantityeffect is stronger and will more than offset the opposite price effect. #hat does that entail for

reenue= !f price decreases and, in percentage terms, quantity rises more than price has dropped,then total reenue will increase. The rules describing the relationship between elasticity and total

reenue (T>). The concept is as follows$

T> % rice " -uantity

?> % TR

Q

?arginal >eenue (?>) is positie as total reenue rises (and the demand cure is elastic).

#hen total reenue reaches its peak (elasticity equals 5), marginal reenue reaches *ero.

#$e 'ross.E%asticit o& !eman"

Cross:elasticity (or cross:price elasticity) deals with the impact (again, in percentage terms) on

the quantity demanded of a particular product created by a price change in a related product

Figure 1 The Relationship between Price Elasticity and Total Revenue (TR)


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(while eerything else remains constant). #hat is the meaning of related products= !n

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 9 resulting from a 5 percent change in the price of product

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Karina Demand Theory and Elasticity Summary