law of economics

Law of DemandLaw of Demand

H ldi ll th thi t t ( t i Holding all other things constant (ceterisparibus), there is an inverse relationshipb t th i f l d dbetween the price of a normal good andthe quantity of the normal goodd d d ti i ddemanded per time period Substitution Effect Income Effect

Copyright 2007 by Oxford University Press, Inc.PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Slide 1

Components of Demand:pThe Substitution Effect

A i th t l i i t t Assuming that real income is constant: If the relative price of a good rises, then

ill t t b tit t fconsumers will try to substitute away fromthe good. Less will be purchasedIf the relative price of a good falls then If the relative price of a good falls, thenconsumers will try to substitute away fromother goods More will be purchasedother goods. More will be purchased

The substitution effect is consistent withthe law of demand


the law of demand

Components of Demand:Th I Eff tThe Income Effect

The real value of income is inverselyThe real value of income is inverselyrelated to the prices of goods

A change in the real value of income: A change in the real value of income: will have a direct effect on quantity

demanded if a good is normaldemanded if a good is normal will have an inverse effect on quantity

demanded if a good is inferiordemanded if a good is inferior The income effect is consistent with the

law of demand only if a good is normalCopyright 2007 by Oxford University Press, Inc.PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Slide 3

law of demand only if a good is normal

Individual Consumers DemandQdX = f(PX, I, PY, T)

quantity demanded of commodity XQdX = quantity demanded of commodity X by an individual per time period

i it f dit X

QdX

P price per unit of commodity X

consumers income

PX =

I = co su e s co e

price of related (substitute or l t ) dit

PY =complementary) commodity

tastes of the consumerT =


Qd f(P I P T)QdX = f(PX, I, PY, T)

QdX/PX < 0 if a good is normalQdX/I > 0 if a good is normalQdX/I > 0 if a good is normalQdX/I < 0 if a good is inferiorQdX/PY > 0 if X and Y are substitutesQdX/PY < 0 if X and Y are complements


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Market Demand CurveMarket Demand Curve Horizontal summation of demand

curves of individual consumers Market demand is also influenced by

Bandwagon Effect when people demand a commodity because

others are purchasing it (e g Tatas Nano Car)others are purchasing it (e.g., Tata s Nano Car) Snob (Veblen) Effect

arises when some consumers want to bearises when some consumers want to bedifferent from other consumers by demandingless of a commodity of mass consumption anddemanding more of expensive products


demanding more of expensive products

Market Demand FunctionQDX = f(PX, N, I, PY, T)

quantity demanded of commodity XQDX = quantity demanded of commodity X

price per unit of commodity X

QDXPX =

number of consumers on the market

i

N =

I consumer income

price of related (substitute or

I =

PY = p ce o e a ed (subs u e ocomplementary) commodity

t t

Y

TCopyright 2007 by Oxford University Press, Inc.PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Slide 10

consumer tastesT =

Demand Curve Faced by a Firm D d M k t St tDepends on Market Structure

Imperfectly competitive markets such as Imperfectly competitive markets such as Monopoly, Monopolistic Competition and OligopolyOligopoly Firm is a price maker

Fi d d h ti l Firms demand curve has a negative slope Perfectly competitive market

Firm is a price taker Firms demand curve is horizontal


Demand Curve Faced by a Firm yDepends on the Type of Product

Durable Goods such as washing Durable Goods such as washingmachines, refrigerators, etc.

Demand is volatile or unstable as Demand is volatile or unstable ascompared to demand for non-durablegoods

Producers Goods that used in theproduction of other goods (e.g., steel,cement, etc.) Demand is derived from demand for final

dCopyright 2007 by Oxford University Press, Inc.PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Slide 12

goods

Linear Demand FunctionLinear Demand Function

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

PPX 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 + TQX 160 10PX + 2N + 0.5I + 2PY + T

Demand Curve for Good XDemand Curve for Good X

Given N = 58, I = 36, PY = 12, T = 112

QX = 430 - 10PX


Linear Demand FunctionLinear Demand Function Example Part 2

Inverse Demand Curve for Good X

PX = 43 0.1QXTotal and Marginal Revenue FunctionsTotal and Marginal Revenue Functions

TRX = 43QX 0.1QX2X X XMRX = 43 0.2QX


Price Elasticity of Demand

/Q Q Q P P i t D fi iti //P

Q Q Q PEP P P Q

= = Point Definition:

Linear Function: 1PPE aQ

= Q


Price Elasticity of Demand

A D fi iti 2 1 2 1Q Q P PE +Arc Definition: 2 1 2 1

2 1 2 1P

Q QEP P Q Q

= +


Marginal Revenue and PriceMarginal Revenue and Price Elasticity of Demand

11MR PE

= + PE


Marginal Revenue and PriceMarginal Revenue and Price Elasticity of Demand

PX1PE >

1PE =

1PE 1) as compared to the demand curve, the less is thetax burden for sellers or the more is the tax burden forbuyersy

When the supply curve for a commodity is less elastic(eps < 1) as compared to the demand curve, the more isthe tax burden for sellers or the less is the tax burden for

Copyright 2007 by Oxford University Press, Inc.7/6/2010

the tax burden for sellers or the less is the tax burden forbuyers

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law of economics